The road to turnaround goes through NBFCs

The road to economic recovery out of the Crisis is, without doubt, pumping of liquidity into the real sector. This is the way financial supervisors have done all over the world, and at all times. This happened in 1929-30, and in 2008.

Now, this is what the RBI was possibly trying to do - by the so-called TLTRO-2, which was a targeted liquidity infusion into NBFCs/MFIs, so that the latter can disburse money to the real sector.

However, the results of the TLTRO-2 auction, concluded today, are very disheartening. Only about half of the Rs 25000 crores infusion, intended mainly for mid-sized and smaller NBFCs, has been taken up by banks. This means banks are not ready to take exposure on NBFCs.

This is a very bad signal, for the economy in general but very particularly so for NBFCs. NBFCs are the agents of financial distribution - this is how money flows from banks to the real sector. If NBFCs do not lend, several sectors - from personal finance to construction equipment finance, will run dry. If that happens, it is virtually impossible to think of a quick turnaround to the so-called V-shaped recovery.

In particular for the NBFCs, the worst-affected will the smaller and mid-sized ones. If banks are not willing to lend, even when refinanced at the repo rate by the RBI and with incentives such as exemption from PSL requirements, it is unlikely that banks will be willing to lend to such NBFCs. At the same time, their own cashflows from customers will run dry at least for next few months.

If intermediated lending through the banking system is not working, the RBI has to think of direct intervention. This is the method used in several countries, including the USA, where the Federal Reserve has set up several direct lending facilities.

It is important to maintain the road of money supply that leads to the real sector. In India, in many respects, that road was through NBFCs. In any case, given the exposure that banks and mutual funds have in the NBFC sector, the country cannot afford another shadow-banking crisis at this time.