NBFC Liquidity Crisis 2018
The NBFC liquidity crisis of 2018 was triggered by the default of IL&FS group entities in September 2018, which caused a sudden freeze in short-term funding markets for non-banking financial companies, threatening a contagion across the broader financial system and prompting RBI intervention through liquidity measures.
IL&FS (Infrastructure Leasing and Financial Services), a major infrastructure finance NBFC, began defaulting on commercial paper and inter-corporate deposit obligations in August-September 2018. These defaults by an AAA-rated entity — credit ratings had failed to signal the deteriorating cash flows — shocked investors and lenders who had assumed such entities were implicitly backed by their institutional shareholders (LIC, SBI, CII).
The contagion mechanism was rapid. NBFCs and Housing Finance Companies (HFCs) relied heavily on short-term commercial paper and debentures for funding, often lending long-term (home loans, infrastructure loans) with short-term borrowings — a classic asset-liability mismatch. When IL&FS defaulted, mutual funds that held large amounts of NBFC commercial paper in liquid and ultra-short duration schemes began facing redemption pressure, creating a feedback loop: mutual funds stopped rolling over commercial paper, NBFCs faced refinancing inability, and credit spreads for all NBFC paper widened sharply.
DSP Mutual Fund's sale of Dewan Housing Finance Corporation (DHFL) commercial paper at a significant discount in September 2018 heightened panic. DHFL, YES Bank, and several other large HFCs and NBFCs saw their borrowing costs spike and their stock prices collapse. The crisis exposed the broader structural vulnerability of the NBFC sector's funding model.
RBI's response came through multiple channels. The Targeted Long-Term Repo Operations (TLTRO), first introduced in March 2020 for the COVID crisis but conceptually built on earlier interventions, was preceded by open market operations (OMOs) to inject durable liquidity. RBI also relaxed rules allowing banks to provide additional credit to NBFCs. The government facilitated partial credit guarantee schemes for NBFC borrowings. SEBI imposed stress test requirements on liquid mutual fund schemes.
Legacy fallout continued for years. DHFL collapsed into insolvency in 2019-20. Yes Bank's exposure to stressed NBFC and real estate accounts contributed to its near-failure in March 2020. The crisis permanently changed the funding landscape for NBFCs, driving a shift toward diversified borrowings with longer tenors, and accelerated RBI's regulatory tightening of scale-based NBFC regulation introduced in 2021.