"Highlighting the banking crisis and the fall of Paytm"
In today's blog, we will discuss two important news making headlines. We will explore the ongoing banking crisis in the country and highlight the Reserve Bank of India (RBI) advice to banks. Additionally, we will uncover the mysteries surrounding the recent collapse of Paytm2 and analyze the current plight of the financial sector.
Banking Crisis:
The financial turmoil in the country has attracted the attention of the RBI, prompting them to advise banks on how to deal with the crisis. Despite the Finance Ministry and the Reserve Bank of India praising the better performance of banks, concerns are being raised about their asset quality and bumper profits. While credit demand indicates positive economic growth, wrong moves by banks can plunge the country into a deep economic crisis.
A trip down memory lane:
In 2018, three major non-banking financial companies (NBFCs) – NBFC Mysore, IEL, and FSDHFL – faced a liquidity crunch due to banks suddenly stopping lending. Subsequent investigation revealed that these companies had distributed money to persons without proper financial standing. The crisis deepened in 2019 with the Punjab and Maharashtra Cooperative (PMC) Bank scam, where bank officials gave substantial loans to HDIL, leading to its financial collapse.
Domino Effect:
The challenges of the banking sector increased one after another, NBFCs faced crisis related to NPA (non-performing assets) and governance issues. The government intervened and urged SBI and LIC to inject funds into IEL and FSDHFL, but PMC Bank, HDIL and PMC officials were not so lucky. The question arises: What caused the simultaneous collapse of NBFCs and banks?
Root causes:
According to a report by Vachan India, the interconnected financial condition of these institutions was a significant factor in their collapse. Fraudulent loans were given to many individuals, creating a web of financial interlinkages. Hundreds of fake companies were formed, loans were obtained and suddenly closed down, causing huge losses to the banks. NBFCs, especially NBFC Mysore, were heavily dependent on bank credit to distribute funds to their customers, which led to huge losses for the banks.
RBI warning:
Despite these worrying developments, RBI's efforts to scrutinize NBFCs like NBFC Mysore have faced resistance. The July 2020 Financial Stability Report reported that NBFC Mysore's bank exposure increased from 23% in March 2017 to about 29% as of December 2019. RBI issues warning and sets rules for monitoring NBFCs, urging them to strengthen their internal monitoring systems. However, compliance with these rules remained lax and banks continued to lend to NBFCs Mysore, leading to economic decline.
Kafeel's perspective:
The Center for Advanced Financial Research and Learning (KAFIL) recently released a report highlighting the potential risks associated with NBFCs like Mysore availing loans from banks. In response, the RBI decided to increase the risk weight for companies issuing credit cards and engaging in similar businesses, including NBFCs. The decision is aimed at mitigating the risks posed by heavy dependence on loans by NBFCs and credit card companies.
Credit Growth and Economic Impact:
Over the past few years, India has witnessed a significant increase in consumer credit allocation. A large portion of these loans, about three-fourths, are unsecured. It is noteworthy that NBFCs, especially those with lower credit ratings, have been actively involved in disbursing these loans. The recent decision of RBI is aimed at increasing the risk weighting, thereby reducing the exposure of banks to NBFCs and credit card companies.
conclusion:
As we analyze the current financial scenario, it becomes clear that RBI's supervision over the Indian banking sector may not be strong enough. Some experts argue that the RBI should separate its roles of setting interest rates and supervising banks, claiming that this separation could provide clear direction and prevent unnecessary conflicts. While it may seem straightforward to suggest curbing large-scale borrowing by NBFCs like Mysore, the practical implementation of such measures remains challenging. Nevertheless, it is necessary to curb their dependence on the bond market, as a deepening crisis in NBFCs could pose significant risks to the country's banking sector.
Paytm market fell:
Without our attention, the stock market's three-day rally came to an abrupt halt on December 7. Along with this, shares of online payment platform Paytm2, a subsidiary of Communications Limited, saw a decline. Shares of Paytm2 hit the lower circuit by 20%, falling to ₹45.45 during the morning session. Although the stock opened at ₹91.55, it touched a low of ₹50.65 within 20 minutes of trading. The company also revised its revenue estimates after market close.
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