BOFIT Seminar - Sonalika Sinha (Reserve Bank of India) - Anatomy of a Liquidity Shock on Non-banks

Co-authors: Nirupama Kulkarni (CAFRAL) and KM Neelima (RBI)

Using a unique supervisory database of non-banking financial institutions (NBFIs) matched to their borrowers and lenders, this paper investigates the anatomy of an exogenous liquidity shock on non-banks that occurred in September 2018 in India. Due to the shock, there was a withdrawal by short-term creditors of NBFIs, making it difficult for them to roll over their short-term debt. Using a difference-in-differences methodology, we exploit the ex-ante differences in NBFIs' exposure to liquidity mismatches for identification. Results reveal that non-bank companies with high ex-ante exposure to liquidity shock see a significant decline in commercial paper growth, attributable majorly to mutual funds, which faced redemption pressure from investors in response to the shock. NBFIs did not substitute with alternate funding sources such as debentures or bank credit in the short run. High-exposure NBFIs subsequently cut down credit to large borrowers. While banks stepped in to support healthy NBFIs, they cut back credit to weaker ones. This selective bank support is enabled through regulatory guidance, and can have beneficial effects during a non-banking shock: ringfencing limits contagion to the traditional banking sector, while providing support to healthier NBFIs.


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