Preserving The Nbfc Edifice

First, is the CRB situation symptomatic of a widespread problem with the sector, or is it an aberration confined to a few unscrupulous companies? Second, if it is a widespread problem, what aspects of the economic environment contribute to its prevalence? Third, where do the solutions lie in terms of the respective roles of the various parties concerned?

In the first few days after the problem came to light, there were many dire predictions about the collapse of NBFC activity following runs on their deposits. Now, a couple of weeks after the event, this fear appears to have been belied as there is no significant evidence about an overall loss of confidence in this sector, at least its more prominent segments. Isolated cases of fraud are not really indicative of overall regulatory failure. All that is needed is that they are dealt with as quickly and as fairly as possible.

However, when one looks at the environment in which these intermediaries operate, there are certain indications of an overall vulnerability to the kind of collapse we saw in the CRB edifice. I shall focus on two. One is the apparent increase in interest rate volatility. When we look at a historical parallel such as the savings and loans crisis in the United States during the 1980s, sharp movements in interest rates clearly had a major role to play. These institutions borrowed for short durations and lent for long durations in the form of housing mortgages. As a result of the elimination of deposit rate ceilings in 1980, they found themselves competing for increasingly higher cost deposit funds with banks and other depository institutions, but were locked into long-term fixed rate mortgage lending. The mismatch led many of them to deploy their incremental funds into speculative ventures such as oil wells and real estate development. As these investments turned sour, many of the institutions in this sector went

bankrupt. How did they get away with these kinds of investments? One reason was that they all had some insurance cover on their deposit liabilities, so depositors were not inclined to look too closely at the asset profile. Another was that in many states which experienced widespread failures, the industry was regulated by a state level agency, which was vulnerable to capture by the very institutions that it was supposed to oversee.

Clearly, NBFCs in India do not typically face similar duration mismatches between assets and liabilities. However, they are in a situation where the boundaries between competitors in depository activity on the one hand and lending activity on the other are rapidly disappearing. The net result of this is inevitably a shrinkage of spreads. This can perhaps to some extent be neutralised by larger volumes. But not everybody is going to be able to achieve these. This exposes the smaller players to the same kind of temptations that the American savings and loan institutions faced