Shadow lenders add to Indian financial risks

25. September 2018, 11:39 Uhr

They are of peculiar relevance as much as imminence for the Indian economy: Non-financial or shadow lenders are the country’s backbone of infrastructure investment. Now these very institutions have slid into trouble.

Shadow lenders such as Infrastructure Leasing & Financial Services (ILFS) are key players on the Indian market for corporate bonds, where they rank among the biggest issuers. Their bonds, in turn, constitute the core assets of specific mutual funds highly popular among households and small savers. The reasoning is much the same as in the developed world: Infrastructure investment companies are deemed to deliver a continuous, reliable stream of returns.

Yet just as much as the rest of the country’s financial institutions, shadow lenders have become embroiled in the sector’s travails in the recent past, weighing down on the economy and increasingly choking credit supply (see other posts on our “Economic Ticker” and issue 3/18 of our monthly bulletin, too). Shadow lenders in particular, however, are threatened by their very business model, issuing short-term debt and using the proceeds to finance long-term loans.

Now, some of those lenders, the mentioned ILFS included, are getting into trouble thanks to their clients’ delayed or sometimes even defaulting debt service, state companies not too seldom among them. In a potential negative feedback loop, many savers might now become inclined to sell their stock in those corporate debt mutual funds, forcing asset managers to sell-off corporate bonds, and thus pushing shadow lenders even further to the brink.

We are not there yet; and in a rare joint statement, the Reserve Bank of India and the Securities and Exchange Board of India have declared to provide non-financial lenders with all the liquidity needed to fend off a crisis. Still, frictions in India’s financial sector augment and continue to constitute a major macroeconomic risk for this leading emerging economy.

[Photo: pprasantasahooo, use under Creative Commons license CC0 1.0]