Historically, SMEs have been relying mostly on informal finance as Banks ignored or ignore them due to lack of proper maintenance of financial data and records. In the past two decades or so, agile NBFCs have helped thousands of entrepreneurs in the country to build businesses and have created huge employment when the Banks fight shy of financing this sector.
The deep-rooted understanding of the local market - the borrowers, the geographies, the asset qualities as well as flexible operations has been helping NBFCs master the art of funding SMEs that may not have any track record to prove creditworthiness. Bank lending to NBFCs for onward lending to SMEs has boosted the growth of these businesses. Mutual Funds (MFs) also have been lending money to NBFCs as it makes business sense because of easier operation and higher profits. It is observed that MFs charge less than Banks because of their low-cost model. Over the period, MFs became more liberal in funding NBFCs as the Banks were grappling with mounting NPAs. It is a fact that even though the fund from Banks / MFs is costly but it suits NBFCs as raising retail funds costs more.
Everything was going well and it was a win-win situation for all stakeholders until AAA rated IL&FS defaulted its payment obligations in August 2018. Thereafter, everything turned topsy-turvy for the NBFCs.
After the debacle in IL&FS, there is concern among the investors. There is also talk of reducing exposure to NBFCs by MFs. With the reduction of liquidity of NBFC papers, MFs are forced to reduce their exposure to this sector. MFs feared a surge in redemption demand and became over-cautious. When NBFCs approached Banks, the responses were lukewarm, the result was obvious and the SMEs are facing a liquidity crunch.
Ironically, this appeared to be a kneejerk reaction by the financial market players. The problem with IL&FS was that it has been borrowing short-term money through commercial papers (CPs) to invest in infrastructure projects, which have very long and at times, very uncertain gestation periods. So, when the cash flows from its many infrastructure projects did not come in line with the projections, IL&FS faced a severe mismatch in its borrowing and lending tenors, resulting in inevitable default and as a fall-out, other NBFCs and MFs have started facing the heat.
The question is can the country afford this impasse? Keeping in view the present state of the economy, the country can ill-afford such a stalemate. Incidentally, I am of the view that IL&FS is a not a typical NBFC. It is one of a kind as it was financing very long gestation project which no other NBFCs were capable of financing. It is a fact that something went seriously wrong in its asset liability management which can be set right by the newly constituted Board of Directors and positive support of RBI and Government of India. But it will be pertinent to reiterate that it is neither right nor sensible to compare all NBFCs with IL&FS.
Under the circumstances, all the stakeholders of economy viz. GoI, RBI, Banks, MFs, and NBFCs must sort out the issues at the earliest to bring back the confidence in the NBFC sector. This is all the more necessary to save the SMEs from disaster. To this end, the step proposed by SBI of buying good quality assets of NBFCs to enhance their liquidity is a very welcome move in the right direction. I am confident that the situation will become normal very soon. What do you think? Do share your opinion in the comment section below.
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