Discuss in detail the crisis being faced by NBFCS in India? Suggest what measures need to be taken to resolve the same? (250 words)

Structure of answer:

  • Introduction (Importance of national security).
  • Need for formulating a national security strategy for India.
  • What are the major shortcomings in India’s national security architecture that must be addressed?
  • Key national security institutions and revamp their functioning.
  • Role of National Security Adviser with respect to accountability and legal formality.
  • Significant features of Hooda document.
  • Way forward.
  • Conclusion.

Non-banking finance companies(NBFCs)

  • Non-banking finance companies(NBFCs)are a fundamental part of the Indian financial system playing a significant role in nation building and financial inclusion.
  • It plays a complementary role to the banking system in promoting financial inclusion. The Non-
    Banking Financial Companies(NBFCs)are the financial institutions that offer the banking services, but do
    not comply with the legal definition of a bank, i.e. it does not hold a bank license. Both banks and NBFCs are
    financial intermediaries.
  • NBFCs can lend and make investments. Hence, their activities are akin to that of banks.

Differences between NBFCs and banks:

  • NBFC cannot accept demand deposits;
  • Banks can maintain demand deposits (savings/current accounts) but NBFCs accept only term deposits;
  • Banks form a part of Payment and Settlement Mechanism but NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself;
  • Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks.

Crisis Being Faced by NBFCS in India:

  • India’s non-banking financial companies (NBFC) sector —also known as the shadow banking system that provides services similar to traditional commercial banks but outside normal banking regulations —is passing through a
    turbulent period following a series of defaults by Infrastructure Leasing and Financial Services (IL&FS) and the subsequent liquidity crunch.
  • The liquidity squeeze faced by NBFCs has led to a conflict between the government and the Reserve Bank of India, with the Finance Ministry pushing for easier fund flows while the RBI insists there’s enough money available in the system.
  • Several corporates, mutual funds and insurance companies had invested in short-term instruments such as commercial papers (CPs) and non-convertible debentures (NCDs) of the IL&FS group that has been defaulting on payments since August.
  • This has stoked fears that many of them could have funds stuck in IL&FS debt instruments which, in turn, could lead to a liquidity crunch in their own backyard. Liquidity conditions had tightened, with a deficit of Rs 1.37 lakh crore on October 22, 2018, though this has declined since.
  • There are rising fears that the funding cost for NBFCs will zoom and result in a sharp decline in their margins.
  • The decline in asset quality for select NBFCs has stemmed from cases where underwriters (a person or company that underwrites an insurance risk) are inexperienced, or with limited understanding of the local situation and dynamics that drive the demand for credit.

Way Forward:

  • Efficient engagement of customers: NBFCs must distinguish between active and inactive customers to develop a focused engagement methodology and allocate resources efficiently.
  • Building effective reward and loyalty programmes to minimise bad debts:NBFCs must increase customer retention by building a strong loyalty programme, with discount, cashback benefits. The program must be customised according to the customer type and factor in the right data variables to provide meaningful incentives and value for customer loyalty.
  • Over the years, NBFCs have played an important role in providing growth capital to various sectors of the economy
  • A concerted effort across stakeholders is required to prevent a market contagion that can cut off the critical supply of capital to the grassroots of the nation.
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