The Big Credit Freeze
A decade after the Lehman Brothers crash, which triggered off a global financial contagion, central bankers and governments around the world are well aware of how quickly panic and tight liquidity can spread and threaten the entire economy.
The government and the Reserve Bank of India (RBI) are working overtime to ensure that a similar panic and liquidity crisis does not get out of hand and roil the economy that is already facing too many other pressures. After 10 months of liquidity deficit for banks, the RBI liquidity tap is back to surplus in the last two months, but will it stay there for long?
The events leading up to the current liquidity crisis in the Indian financial system started, ironically enough, with an attempt by the Indian banking regulator to clean up the system four years ago. In 2015, the RBI initiated the asset quality review (AQR) of banks to unearth the number of bad loans that were hidden in their balance sheets. As skeletons in the loan cupboards of many public sector banks and a few private sector banks came tumbling out, the RBI realised that close to a dozen banks did not have the wherewithal to continue lending without cooking books.
It put them under what it called the prompt corrective action (PCA) watch and forbade them from lending afresh unless their capital adequacy was shored up. The government, also determined to clean up the financial Augean Stables, passed the Insolvency and Bankruptcy Code (IBC) to force lenders to take recalcitrant borrowers to bankruptcy court instead of giving them even bigger loans with which they paid back their earlier loans.
Meanwhile, as banks became supposedly more prudent about their lending, an even bigger storm was inadvertently triggered off. As banks focussed on cleaning up their books and lending more cautiously to troubled sectors and businesses such as real estate and infrastructure, the non banking financial companies (NBFCs) and housing finance companies (HFCs) were making hay and experiencing growth like never before. They had stepped into the breach and started providing funds to not only troubled sectors but also small and medium enterprises that found it difficult to get project loans from banks. The problem was that the NBFCs and HFCs often called shadow banks because they lend like banks but have fewer constraints of regulation were actually borrowing short term money from banks and
