In the month of September, we saw panic in financial markets as a large NBFC defaulted on its short term loans and commercial papers. There were rumours of a mini Lehman moment for the Indian financial industry as this company owed around Rs. 63,000 crores⁽¹⁾ to various lenders including Banks, Mutual Funds and other NBFCs. Coming on the decennial anniversary of 2008 meltdown, markets were spooked and some NBFCs lost more than 60% of their market price⁽¹⁾.

Many investors did panic resulting in redemption pressures for a lot of fund houses. Quite a few fixed income investors saw a lot of volatility in their investments. That’s not all. There were multiple economic & financial cascading effects of a large Financial Institution going bust. But did that alone cause the liquidity crunch? According to various experts this merely added to the liquidity crunch essentially caused by ⁽²⁾

1. RBI increased the rates twice in July and Aug’18. Rise in interest rates usually result in liquidity moving out of financial markets as investors prefer the safety of bank deposits ^{(2) (3)}
2. Since RBI had taken measures to identify weak banks & strengthen their balance sheet through Prompt Corrective Action or PCA framework. Essentially PCA tries to ensure credit quality, profitability and interest margins for weaker banks. ^{(5) (6)}

Given the above, the said default only exacerbated the situation. Banks who are the primary lenders to NBFCs were unable to or were hesitant to lend given the PCA norms. This led to overall belief that there were imminent defaults waiting to happen in the NBFC space. However, RBI believes that there is enough strength in NBFCs and liquidity in overall market to tide over this scenario. ⁽¹⁾

Moreover, RBI and Government have moved with alacrity to ensure that the default was contained. Government superseded the company’s board of directors with its own board of directors led by Mr. Uday Kotak, Managing Director of Kotak Mahindra Bank. The new board will finalize the information memorandum and the request for proposal (RFP) for auctioning the assets in consultation with the lenders and shareholders. This should help ease the stress and liquidity caused by the default.

RBI too has infused about Rs 8,000 crore⁽⁴⁾ into the system in the month of November through the government securities to meet the liquidity demand. In October, the central bank had already injected Rs 36,000 crore through open market operations.⁽¹⁾ The government and RBI also had discussions around how to deal with liquidity challenges.⁽⁷⁾ There were differences of opinion which got widely reported. In the 19^th November board meeting of RBI, the government and central bank reached the following consensus to aid the situation:

1. RBI would ease the NPA norms for Small and Medium Scale enterprises
2. It decided to retain the capital to risk weighted assets ratio (CRAR) at 9%, agreed to extend the transition period for implementing the last tranche of 0.625% under the Capital Conservation Buffer (CCB), by one year, i.e., up to March 31^st, 2020. ⁽⁶⁾
3. With regard to banks under PCA, it was decided that the matter will be examined by the Board for Financial Supervision (BFS) of RBI. ⁽⁵⁾

Overall, the markets have now stabilized. As per Mr. Mahesh Patil in Nov’ 2018 Empower, “Fear in the market has led to distressed prices and good value is emerging in individual stocks. The recent correction provides a good opportunity for prudent investors to build equity exposure for the long term. Investors will be better off doing SIPs/STPs for the next 6-9 months, rather than lump sum investments, so as to benefit from any fall in the market. (Source: ABSLAMC Research) It would also be prudent for investors to allocate 20% of their corpus to midcap and small cap funds. Valuations in that space have become reasonable and we remain constructive on overall economic growth.”

As the noise subsides, investors who did not panic and continued their SIPs will benefit from the value picks.

You may also Read about - What is Liquidity?

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

References:

1. https://www.financialexpress.com/industry/banking-finance/all-you-need-to-know-about-current-liquidity-crisis-at-indias-nbfc/1370224/
2. https://www.thehindubusinessline.com/money-and-banking/india-chooses-between-a-falling-rupee-and-a-banking-cash-crunch/article24591225.ece
3. https://timesofindia.indiatimes.com/business/india-business/rbi-raises-interest-rate-by-0-25-on-inflationary-concerns/articleshow/65228342.cms
4. https://www.financialexpress.com/market/rupee-rises-to-nearly-3-month-high-vs-usd-after-rbis-rs-8000-crore-liquidity-infusion-plan/1387115/
5. https://www.thehindubusinessline.com/money-and-banking/health-of-banks-being-restored-under-pca-regime-rbi-official/article25208136.ece
6. https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/PCAFR060514_4.pdf
7. https://www.ndtv.com/india-news/rbi-board-meeting-live-updates-in-heightened-alert-markets-investors-wait-for-outcome-1949560