Bad Loans, Stranded Money And The R-Naught Of Credit Markets
The Covid-19 Care Center set up at the CWG Village Sports Complex in New Delhi. (Photographer: T. Narayan/Bloomberg)

Bad Loans, Stranded Money And The R-Naught Of Credit Markets


Imagine a patient traumatised by catastrophic injuries, followed by a cardiac arrest. Think of the Indian financial sector as a patient heaving from the effects of eight quarters of an economic slowdown, followed by a lockdown.

Imagine the patient is wheeled in and treated under a new technique called suspended animation, aka emergency preservation and resuscitation, or EPR, where the body temperature is brought down to 15 degrees using ice-cold saline. At normal temperature the need for oxygen is high. EPR brings down the need. In effect, the process is not dissimilar from post-Covid measures – the extension of emergency credit lines and moratoriums to freeze systemic ruptures.

Imagine unlocking as the patient waking up. What about post-operative risk management to prevent the recurrence of trauma? Forecasts estimate a contraction in the economy of between 4.5% made by the IMF and 9.5% by ICRA. Stress and distress are aggravated, bad loans are mounting, and the quantum of stranded money is rising.

Bad Loans, Stranded Money And The R-Naught Of Credit Markets

Imagine if there was an R0 or R-naught for India’s credit markets. R0 or R-naught is a mathematical term used to indicate how contagious an infectious disease is. The eloquence of this expression has the potential for wider usage and footprint.

As it is in epidemiology, the R-naught of bad loans would factor variables to map risks.

To appreciate the construct and the magnitude of fragility consider the landscape littered with unattended causes afflicting lenders, borrowers, and savers.

The Lenders

July 2020 marks 24 months since the bust-up of Infrastructure Leasing & Financial Services when it missed payments, and its chief quit the board. Delays morphed into default and in November 2018 the government ring-fenced IL&FS from creditors using a special dispensation at the NCLAT. Of the Rs 99,254 crore owed by IL&FS less than a third has found resolution.

On June 4, 2019, Dewan Housing Finance Corp., a housing finance company, missed interest payments of Rs 960 crore. A day later rating agency CARE downgraded DHFL from A to D. Indeed as IL&FS went down, it signaled the mess at DHFL as early as September 2018. By December 2019, DHFL made its way to the NCLAT. The outstanding amount: Rs 1,02,500 crore. Creditors are in the queue awaiting resolution.

The collapse of Yes Bank Ltd. was foretold in its books. Between 2014 and September 2019 the bank’s lending book quadrupled to over Rs 2,25,000 crore, exceeding its deposit growth which stood at around Rs 2,00,000 crore. Its bad loans list included IL&FS and DHFL among other enterprises with dubious business models. Depositors were denied access to savings and the bank was bailed out by State Bank of India with an unprecedented line of credit from the Reserve Bank of India.

The saga of IL&FS, DHFL, and Yes Bank symbolise a pattern.

Due diligence is the ‘social distancing’ of the credit markets. Infection rises with contact and transmission. In each case, the rot was visible yet like the cops in Bollywood movies the board, the auditors, the rating agencies, and the regulator waited till the climax to appear and deliver the perfunctory cameo performance.

The Borrowers

The impact of the severe slowdown in the economy was manifest in the books of lenders and stress tests of the RBI with bad loans rising over Rs 11 lakh crore. The worst-hit sectors were MSMEs and the housing and construction segments. As with Covid-19 infections, vulnerability is aggravated by existing conditions.

The contribution of MSMEs is well documented – they create jobs, nearly 30% of GDP, and 48% of exports. In June 2020 rating agency CRISIL put out a report titled ‘The epicentre of an existential crisis’. One factoid captured the haplessness of small entrepreneurs succinctly. It stated, “about 70% of 40,000 companies have cash to cover employee cost for only two quarters, mostly MSMEs.”

Construction and housing are leading indicators and multipliers of demand, consumption, and economic growth. Located at the intersection of the rural and industrial economy it is arguably the second-largest employer after agriculture. The total exposure of lenders to construction and housing is estimated at around Rs 7 lakh crore.

The failure of a micro, small, or medium enterprise impacts forward and backward linkages of output and credit. Similarly in construction, retrenched demand affects lenders, suppliers, and downstream contractors.

A failed or stalled housing project impacts banks, NBFCs, housing finance companies, and savings of the buyer stranded with an EMI and no house.

Stranded Money

India’s political economy frequently presents unique phenomena. The most recent addition is ‘stranded money’ – that is dues receivable but not available, earned, but not paid. And the roster of delinquency includes governments and public sector enterprises, besides large corporates.

The fate of companies that supply power to state electricity boards symbolises the saga. As per data on ‘overdue amount’ released by the Ministry of Power at, as of May 2020, governments across India owe 36 generating companies and 40 non-conventional generating companies a sum of Rs 1,17,135 crore. Also in the queue for dues are MSMEs. The estimates vary depending on who is telling. MSME Minister Nitin Gadkari estimated the dues at around Rs 5 lakh crore. An expert committee analysed 18,647 applications for dues and put the outstanding dues at Rs 4.81 lakh crore. Even as the government claims dues are cleared, MSME Samadhaan reveals 48,789 applications were filed for dues.

As with many data points in India, the exact figure is fuzzy. What is clear is that MSMEs struggle to get their dues and that their money is stranded between declared political intent, exchequer ability, and systemic apathy.

The Savers

Caught in the maelstrom with little or no recourse for speedy resolution are savers – whether it is the fallout on fixed-maturity plans of delays or defaults by promoters who were lent money, whether it is investors of IL&FS, DHFL, or Yes Bank bonds, or those holding the stubs of mutual funds under suspension.

Economic growth is powered by money which savers trust the system to manage – this includes over Rs 100 lakh crore of deposits with banks, around Rs 16 lakh crore deployed by NBFCs, over Rs 14 lakh crore of funds managed by mutual funds.

The credit markets are wired in serial. Any disruption in the flow due to defaults or dues represents a systemic risk not just to the savers and lenders but also to the larger economy and has political consequences.

R-Naught Of Risks

The crisis affords a window to recast the business model of banking. It is true that some steps are already underway. The government has allowed and nudged banks to raise money to boost capital for eventualities. The RBI is planning on a one-time restructuring formula to alleviate distress in sectors. The recapitalisation of banks and restructuring of loans are necessary but not sufficient.

Roughly a third of the loans of private lenders and two-thirds of public sector banks are under the government moratorium. When the moratorium ends, EMI flows will depend on if the borrower has a job and the entrepreneur still has a business. Earlier this month rating agencies informed the Reserve Bank of India that they may withdraw nearly half of India debt ratings if issuers/companies fail to share information. What if even a tenth of accounts under moratorium flail?

‘Resilience’ calls for cleaning up the bipolar disorder of ownership and regulation.

At a macro-level, the government must diminish its equity ownership and enhance the accountability of owners. At a micro-level this requires analysis of business models by boards, forensic scrutiny of transmission risks by auditors and rating agencies, and agile intervention by regulators.

India will also need to leverage data to determine and flatten the arc of risks, create a real-time risk estimate system. The mapping of risks and management of fragility in the financial sector is akin to pandemic management and demands contact tracing, isolation, and treatment.

Maybe it is time to imagine an R-naught for assessing and managing risks in the credit markets!

Shankkar Aiyar, political-economy analyst, is the author of ‘The Gated Republic –India’s Public Policy Failures and Private Solutions’, ‘Aadhaar: A Biometric History of India’s 12-Digit Revolution’; and ‘Accidental India’.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.

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