By disrupting the cycle of sourcing, value adding and the final conversion to cash of almost all businesses, the lockdown has triggered a wave of demands for cash flow relief. The most obvious candidates were loans and taxes, where moratorium definitely eases the pressure temporarily. Which is perhaps why the RBI was among the first off the block to announce a moratorium package for borrowers.

Tax revenues will in any case take a beating given the sudden fall in consumer spending, but tax forbearance has much wider ramifications because the government’s capacity to spend is itself predicated upon adequate tax collections. It is this network of dependency that makes relief so difficult to formulate — forbearance for one section is certain to impose hardships on the other. This was one of the issues with the RBI moratorium package which left intermediate borrowers such as NBFCs (including MFIs) in a cleft.

Though the RBI seemed to justify it on the grounds that most NBFCS were liquid enough not to need help, the presumption raises questions because both banks and non-banks were in the same business. It ultimately rolls down to the robustness of cash flows of financial firms, an issue seldom debated except when defaults occur, as with IL&FS.

We must remember that financial intermediaries depend more upon loan repayments and borrowings (not necessarily in that order) than internal profit accruals to sustain their business. Profit margins are wafer thin because lending is considered a low-value-added activity. Though it may appear that banks were also sacrificing their cash flows, banks enjoy privileges which non-banks do not.

The bulk of banks’ borrowings are in the form of deposits; nearly 40 per cent of these (the CASA portion) constitutes transactional money, not financial savings that move in line with interest rates or repayment record. It is the uninterrupted deposit flow, especially CASA, that helps banks overcome the loss of cash flow from their over ₹9 lakh NPA portfolio (conservatively, the loss of interest income could be ₹90,000 crore annually at the weighted average lending rate of 10 per cent, not to speak of loss of principal repayments).

Assisting NBFCs

But NBFCs have a more fragile borrowing profile, made up of loans from banks, NCDs and Commercial Paper (CP). The risk arises from the fact that both CPs are NCDs are largely funded by mutual funds (MFs) who are themselves vulnerable to redemption pressures, since both these instruments are subject to the vagaries of mark-to-market valuation. Therefore the case for extending relief to NBFCs is strong although the mechanics can be complicated given the nature of the debt instruments involved.

The government may be constrained by fiscal deficits and falling tax revenues, but the RBI seems to be trying to ensure that banks have adequate liquidity. In its follow-up package, it aims both to enhance liquidity (targeted long term repo operations, reduction of LCR ratio, additional funding to refinancing agencies) and remove irritants to lending (relaxation of asset quality and provisioning norms).

While relaxing asset quality norms may sound like granting relief to borrowers, we must remember that these were actually intended to rein in banks from lending recklessly. Capital constraints continue to remain for most public sector banks as also the risk of accumulating bad loans when all this is over. But thus far bank credit has been in the dumps primarily for two reasons — no investment demand forthcoming from corporates and risk aversion on the part of banks.

Change course

In the changed circumstances, kick-starting the economy would mean keeping the show running and, therefore, working capital demand is bound to rise even in the backdrop of reduced operations. Therefore, banks must also change course (currently skewed towards retail and long term lending) and ramp up working capital lending. This will be the quickest way to reach cash to companies, especially MSMEs, which should at least help avoid precipitous actions such as lay-offs or shutdowns which could exacerbate the problem.

It is interesting that the RBI has considered specific relief to the construction sector given its importance both from its contribution to the GDP and in terms of the large employment of unskilled and migrant workers. But unfortunately this sector was already mired in many problems and the RBI’s token measures may not mean much. To top it all, the banking system, especially public sector banks, may themselves not be in the best of positions to respond quickly what with big bang mergers to be gone through.

The writer is an independent financial consultant

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