The Big Credit Freeze

The shortage of funds is threatening key sectors of the economy. What the government needs to do to fix it.

- Anand Adhikari

A decade after the Lehman Brothers crash, which triggered off a global financial contagion, central bankers and governments around the world are well aware of how quickly panic and tight liquidity can spread – and threaten the entire economy.

The government and the Reserve Bank of India (RBI) are working overtime to ensure that a similar panic and liquidity crisis does not get out of hand – and roil the economy that is already facing too many other pressures. After 10 months of liquidity deficit for banks, the RBI liquidity tap is back to surplus in the last two months, but will it stay there for long?

The events leading up to the current liquidity crisis in the Indian financial system started, ironically enough, with an attempt by the Indian banking regulator to clean up the system four years ago. In 2015, the RBI initiated the asset quality review (AQR) of banks to unearth the number of bad loans that were hidden in their balance sheets. As skeletons in the loan cupboards of many public sector banks – and a few private sector banks – came tumbling out, the RBI realised that close to a dozen banks did not have the wherewithal to continue lending without cooking books. It put them under what it called the prompt corrective action (PCA) watch – and forbade them from lending afresh unless their capital adequacy was shored up. The government, also determined to clean up the financial Augean Stables, passed the Insolvency and Bankruptcy Code (IBC) to force lenders to take recalcitrant borrowers to bankruptcy court instead of giving them even bigger loans with which they paid back their earlier loans.