EQUITY UPDATE - India Credit Crunch: IL&FS and Yes Bank

Cindy discusses India's credit crunch and the RBI's efforts to clean up the financial sector

India Credit Crunch: IL&FS and Yes Bank

On Friday, the Nifty bank Index (NSEBANK) was down 3% on worries over the financial health of infrastructure lender, Infrastructure Leasing & Financial Services (IL&FS) and the forced departure of Yes Bank founder and CEO, Mr. Rana Kapoor. Since the beginning of the year, the Reserve Bank of India (RBI) has taken a more aggressive stance in cleaning up the financial sector. Critics claim its aggressiveness is pushing weak firms to brink and driving up financing costs for the entire economy.

The Modi government has been struggling to get India’s non-performing loan (NPL) ratios down despite a variety of policies over the last few years to resolve stressed assets and to recapitalize banks. This year the RBI forecast NPLs to increase to 12.2 % by March 2019 from 11.6% in 2018 prompting a directive of more stringent loan classification, a crack-down on lending fraud, greater management accountability and forced mergers.

The biggest step was taken in February when the RBI surprised the sector by cancelling all debt restructuring schemes deeming that they were taking too long. It directed banks to classify all restructured loans as NPLs and ordered that defaulting companies with credit balances over Rs 2,000 crore (INR 20bn) should be referred to the National Company Law Tribunal (NCLT) if the creditors were unable to find a resolution by mid-September. It is estimated that over seventy accounts are impacted involving approximately Rs 3.6 trillion ($52bn) of obligations with most of the problem assets in the power sector.

Additionally, the RBI has been more proactive in kicking out bank management that has under-reported loans or been involved in lending fraud. Last week, the RBI announced that Yes Bank CEO, Mr. Rana Kapoor could only stay on until the end of January 2019 after it determined that the financial institution has understated bad debts by Rs104.7bn ($1.45bn) in the 2016 and 2017 financial years; prompting a 29% drop in its share price.

The move follows on the bank of the RBI voting down the three-year tenure extension of Axis Bank’s CEO, Shikha Sharma in April. The country’s third-largest private lender was also found to be under-reporting bad loans and was implicated in money laundering during the demonetization period. Currently, the head of ICICI is also under investigation.

The stricter measures from the RBI to clean-up the country’s stock of bad debt, in addition to its activities to prop up the currency, has led to a retrenchment in credit and a rise in financing costs. With one-year corporate notes at their highest level in three years, some highly indebted companies are started to feel the pressure with IL&FS the latest firm to make headlines.

IL&FS has been active in many high-profile infrastructure projects in India over the last few years and is highly dependent on short-term financing. In August, it missed several debt repayments causing concern among many institutional investors and prompting an RBI audit. According to a Bloomberg report, the firm has only $27 million readily available, and about $500 million of obligations over the next six months.

Last week, Moody’s lowered their ratings on several IL&FS debt instruments leading to a panic in the whole sector which was extended to the rest of the non-bank financial group, including Dewan Housing Finance and India bulls.

The government and RBI are now left with a tough choice to either continue with their more draconian efforts at banking sector clean up, or to give the companies relief in the form of more capital injections and looser liquidity. The finance ministry has stated this year that no new funds with be allocated; preferring mergers between good and bad institutions. Last week, finance minister, Mr. Arun Jaitley, announced a proposed merger of Bank of Baroda, the third-largest state lender, with smaller firms Dena Bank and Vijaya Bank.

However, if funding continues to dry up, and with the RBI pursuing tighter policy to defend the currency, the Modi government will likely be pushed to provide more taxpayer money to help facilitate mergers or to bail-out indebted sectors or companies.

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