It’s an eerie coincidence that the Indian financial system was hit by a default at the country’s biggest infrastructure lender, just as we marked 10 years of the global credit squeeze sparked by the collapse of Lehman Brothers. The crisis at IL&FS, floundering under debt of Rs.910 billion, has triggered a crisis of confidence in the financial system with lenders turning wary of NBFCs. 

Over the past five years, NBFCs dominated the financial landscape by filling up the space vacated by public sector banks in the wake of a Rs.10 trillion NPA build-up in the banking sector. With India Inc embarking on a deleveraging spree and the government looking to contain the fiscal deficit, there was surplus liquidity. 

While banks have been a major source of funding for NBFCs, a sharp drop in short-term money rates spurred by record flows into debt market funds over the past couple of years saw NBFCs slowly switching over to short-term wholesale market borrowing, which eventually formed a chunk of their liability profile. However, the IL&FS default has triggered a domino effect with debt funds now shying away from these once-favoured borrowers.

Now, NBFCs that have gone all out to build their book issuing credit to all and sundry — from retail borrowers availing EMIs for high-end cell phones to dodgy developers pushing ambitious projects — not only face the challenge of bridging their asset-liability mismatch amid rising cost of funds and heightened risk perception but also have to deal with the credit risk in their portfolios. Retail loan delinquencies usually take longer than corporate loans, and we are still in uncharted territory here, but an imminent risk is the exposure to real estate developers in the books of housing finance companies. That a lot of it is short-term money makes it more vulnerable. 

With rising rates, liquidity getting squeezed and a crisis of confidence in NBFCs, the gravy train seems to have come to a halt. That is the focus of this issue’s cover story that begins on page 18. Whenever NBFCs failed in the past, the banking system was robust and there was hardly any threat because of their failure. That’s no longer the case and precisely why investors are edgy.