Dubai: Funding of NBFCs from commercial banks increased significantly upon the Infrastructure Leasing & Financial Services (IL&FS) distress event and remains substantial, helped by Reserve Bank of India Policies. However, data on mutual fund holdings of shadow bank commercial paper suggest funding pressure continue to exist according to the Institute of International Finance (IIF).

“Mutual funds are steadily reducing their exposure to shadow banks. Non-resident portfolio flows to shadow banks, a useful sentiment indicator, dipped late last year but staged a recovery in recent months, despite broadly weak capital flows to emerging markets. However, the weight of shadow-bank debt in Indian portfolios of non-resident investors remains below mid-2018 levels, suggesting markets still take a somewhat cautious approach to shadow banks,” said Reza Siregar, Head of ASEAN & India Research at the IIF.

Analysts say failure of leading NBFCs could have a domino effect of on the financial markets and the economy, starting with banks, financial institutions and mutual funds losing money while, businesses, especially small and medium enterprises finding it difficult to raise money as NBFCs retrench lending.

According to the IIF, while stable, the funding situation of shadow banks appears tighter than in recent years. This is having an impact on the total flow of credit to the commercial sector. Credit from banks and foreign sources was relatively stable last fiscal year, but shadow banks retrenched.

“Slower lending by shadow banks works out to a credit impulse that is markedly negative. This means the propagation of the shadow-banking shock was fast, as IL&FS defaulted in August and the annual data we use cover the period April 2018-March 2019. We expect the impact of tight funding conditions on lending by shadow banks to continue increasing this year, likely yielding a more negative credit impulse that will weigh on growth,” said Siregar

What happened to IL & FS

Infrastructure Leasing & Financial Services (IL&FS) is a three-decade-old infrastructure lending giant. It is a ‘shadow bank’ or a non-banking financial company.

The major shareholders of IL&FS include state-backed Life Insurance Corp of India holding, 25.3 per cent stake, Housing Development Finance Corporation with 9.02 per cent, Central Bank of India with 7.67 per cent and State Bank of India with 6.42 per cent.

Other key shareholders are the Japan’s Orix Corp, holding 23 per cent, and Abu Dhabi Investment Authority with 12.56 per cent.

L&FS defaulted on a few payments and failed to service its commercial papers (CP) on due date — which meant the company has run out of cash or it is facing a liquidity crunch, sending shock waves in the financial market.

The company piled up too much debt to be paid back in the short-term while revenues from its assets are skewed towards the longer term.

IL&FS Financial Services disclosed on September 6 that the commercial papers (CP), which were due on August 28, could not be paid on due date and were settled in full on August 31. A potential for systemic disruption and financial sector meltdown forced the government to seize control of IL&FS and its units by superseding the board.