As per a research paper co-authored by the erstwhile Chief Economic Advisor, Mr. Arvind Subramanian in November 2019, India was already suffering from a Twin Balance Sheet (TBS) and a Four Balance Sheet (FBS) problem. (An entire summary of the research paper can be accessed here.)
The first wave of Balance Sheet crisis arrived in the form of TBS covering Banks and Infrastructure Companies right after the Global Financial Crisis (GFC) when the world economy slowed and the projects started during India’s investment boom of mid – 2000’s began to go sour. Repayment of these loans became a challenge.
The TBS extended into a FBS when NBFC’s and Real Estate sector also came into the picture. In terms of lending, NBFC’s can take on additional risk in lending since public money is not involved (they cannot accept deposits).
The trigger for slowdown occurred with the collapse of ILFS in September 2018. The failure of ILFS being a behemoth with Rs. 90,000 cr. of debt, sent shockwaves throughout the financial system. This led the entire market to re-assess the NBFC situation.
Banks had been lending to NBFC’s who in turn started lending aggressively to the Real Estate sector.
Lending to NBFC’s by Banks instead of direct lending to the real estate sector had a lower charge on the risk-weighted assets.
Starting in the mid-2000s, developers had been aggressive in launching new housing projects, on the assumption that high earners and the emerging middle class want to live in better homes and deploy their newfound wealth in real estate.
Unsold housing inventory in top eight cities has increased to 10 lakh units by end of June 2019 against annual sales of just over 2 lakh units.
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What to do?
a. Launch a new asset quality review to cover banks and NBFCs (Recognition): After the first Asset Quality Review (AQR) was conducted in the year 2006, it was felt that the Recognition issue was behind us, but after the AAA rated ILFS default, we are yet to know the full picture of the existing stress.
b. Make changes to the IBC to better align incentives (Resolution)
c. Create two executive-led public sector asset restructuring companies (“bad banks”), one each for the real estate and power sectors (Resolution): Freeing up bad assets related to real estate and power sector from the balance sheets of commercial banks will allow banks to start focusing on their core business of supporting economic growth.
d. Strengthen oversight, especially of NBFCs (Regulation)
e. Link recapitalization to resolution (Recapitalization)
f. Shrink public sector banking (Reform): Private banking has proved imperfect but public sector banking (PSBs) has proved to be decisively flawed. The age-old problem of political interference and decision-making inertia is well-known. India’s public sector banks lack—and will always lack–the basic risk management framework to conduct any semblance of prudent banking. And once the imprudent loans turn bad, public sector bankers have little incentive to resolve the problems.
g. Better data for policy navigation: There is immediate need to reboot the data systems in three sectors – real (measurement of GDP, employment, and consumption), fiscal (taking care of off-balance sheet items, clean – up of both debt and deficit numbers in the forthcoming budget) and financial (undertaking a comprehensive AQR).
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