We don’t need more financial trainwrecks

There is a slow train rolling into financial markets; it’s been leaving in its wake marquee names such as IL&FS and YES Bank, among others. Spanning non-bank finance companies (IL&FS, HDIL) and banks (YES Bank with ₹2.4 trillion in assets) and PMC Bank, ₹8,000 crore of assets), the train has now hit asset management company Franklin Templeton, and in particular their debt funds. These debt funds lend money to companies, and in return, offer investors typically a return of 1 percentage point over and above what a bank’s fixed deposit would offer. The returns and liquidity keep most of the investors happy.

With the announcement of the closure of such funds by FT, the AMC has been added to the range of institutions facing challenging times and carrying the potential of losing some of their depositors’ money. Given the inter-linkages that exist in the financial sector, it is very likely we are going to witness more wreckages.

Stopping this crisis from unfolding is a complex task. Any solution will have to address two broad drivers that cause this: first is the hope that a turnaround happens in the economy; this will enable growth in the portfolio and reduce the rapid rise of non-performing assets ( NPAs). The second set of drivers pertains to the confidence that investors, depositors and others sets of stakeholders have in the institutions in which they deposit their savings.

Crisis of confidence

It is this signalling of confidence that is the first recourse of fiscal policy in any financial crisis; this prevents a unreasonable immediate demand for the return of savings (called a “run” otherwise) on the institution/bank/fund and allows it to return the money as it receives it from its borrowers. It is only after this “run” is stopped that other solutions can be undertaken.

Recognising that redemption pressure on the funds might require liquidity, the RBI has stepped in and provided liquidity through banks to the mutual funds. While this move has been helpful, it does not seem sufficient. This was evident in the withdrawal of almost ₹11,134 crore of exits from other similar funds. Resolving this crisis of confidence requires more than liquidity.

What is evident is that “credit” to enterprises is suspect, as the lockdown has restricted their ability to meet existing liabilities. From all public accounts, it seems that there has not been a significant problem of repayment yet from any of the Franklin Templeton fund’s borrowers. What is evident is that this fund took risks and invested in paper which rated AA and below; and in companies such as as Rishanth Wholesale Trading (₹604 crore), Piramal Capital & Housing Finance (₹1,001 crore), Greenco Clean Energy (₹301 crore), Aptus Value Housing Finance (₹387 crore), Hero Solar Energy (₹437 crore), and Renew Solar Power (₹204 crore), among others. 4 There is nothing wrong with this. Economic growth requires credit to flow into a variety of sectors.

Where’s the problem?

What perhaps aggravated this “loss of confidence” in the NBFCs was the non-utilisation by banks of the full limit of the TLTRO 2.0 money. This was low-cost money given to banks to refinance NBFCs across a range of sizes and sectors; the banks only utilised ₹12,500 crore. What we can only reasonably conclude is that the banks, too, had exhausted their comfort for risk in relation to these sectors or had reached their financial exposure limits.

Which are these sectors that are causing so much angst? Early reports suggest that much of the exposure of almost ₹308 billion in Franklin Templeton is, among other things, to sectors such as clean energy, affordable housing finance, infrastructure, asset reconstruction and small business finance. While one can debate about the individual companies or instruments, these sectors as a whole are very critical to the economy.

More importantly, Prime Minister Narendra Modi has put his weight behind at least two of those areas: clean energy and affordable housing. Building any sector requires economic policy to incentivise the flow of lending money into these sectors.

The forthcoming measures from the government need to now leverage on what the RBI has done. Loan portfolios need servicing till such time that assets start yielding cash. Clean energy, for example, is estimated to generate 30,000 watts and requires almost $80 billion. YES Bank is estimated to have an exposure of ₹12,000 crore into such projects, and should there be no additional lending, these assets will decline both in value and in their potential for throwing up cash. Should however, lending slow down or not address legitimate demands of these projects, both banks (other than YES Bank) and other debt funds are in danger of loosing their principals.

If we have to protect investors’ and depositors’ money, fiscal measures are needed to address the needs of these operating firms.

No easy task

Designing a rescue package is not going to be easy. Each of these sectors has distinct characteristics. Complexities of regions such as Tamil Nadu will require different attention from Gujarat. In addition, units of different sizes with borrowings of ₹50 crore, ₹15 crore, and down to ₹10 lakh will need different kinds of support. While this approach suggests complexity, it is important to address the diversity that India possesses now, if we are to move the needle on the economy. With decades of data in credit bureaus, information is available for crafting and building an informed strategy (see Table). Layering this data with instruments that build confidence is the next step.

These instruments and policy interventions should have the immediate impact of assuring both the depositors and the bankers that the immediate losses, should there be any, could be cushioned by government money. These new structures can be in the form of first-loss default guarantees, and should cover sectors such as energy, MSMEs including microfinance, etc. Alternatively, other financial instruments such as preferential shares with cumulative coupon or subordinated debt can be offered depending on the nature of the problem in a particular sector or enterprise.

There are enough specialists in this country who can look at each of the sectors, and design instruments, should the will and the consensus for medium term fiscal intervention exist. Clearly the government will have to be creative in not only working with new partners who can help with the analysis and development of each of the sectors but also a whole range of new instruments.

Such a policy measure will be a powerful affirmation that these national priorities will be supported by instruments that would not distort the price and the market but rather encourage the supply of such goods/services. In addition, it will support the expansion of these markets to poor households and low-income regions. It is only such a range of measures that will assist in stopping this slow train from rolling in. The government should “pull the chain” to stop this slow train from causing more wreckage!

The writer is Managing Partner at Market and Ecosystem Advisory