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Which of the following is the reason for NBFC liquidity crisis ?
- a)Short term liabilities (asset-liability mismatch)
- b)Interconnectedness between various NBFCs
- c)Huge exposure to long term assets
- d)All of the above
Correct answer is option 'D'. Can you explain this answer?
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Verified Answer
Which of the following is the reason for NBFC liquidity crisis ?a)Shor...
The correct option is D.
When liabilities far exceed assets in any period, it may lead to liquidity stress for the NBFC. Financially weaker NBFCs are prone to run mismatches in the short-term maturity. Default in IL&FS bonds sparked a liquidity squeeze that spread to other NBFCs.At the root of a liquidity crisis are widespread maturity mismatching among banks and other businesses and a resulting lack of cash and other liquid assets when they are needed. Liquidity crises can be triggered by large, negative economic shocks or by normal cyclical changes in the economy.
When liabilities far exceed assets in any period, it may lead to liquidity stress for the NBFC. Financially weaker NBFCs are prone to run mismatches in the short-term maturity. Default in IL&FS bonds sparked a liquidity squeeze that spread to other NBFCs.At the root of a liquidity crisis are widespread maturity mismatching among banks and other businesses and a resulting lack of cash and other liquid assets when they are needed. Liquidity crises can be triggered by large, negative economic shocks or by normal cyclical changes in the economy.
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Which of the following is the reason for NBFC liquidity crisis ?a)Shor...
Reasons for NBFC Liquidity Crisis:
1. Short-term Liabilities (Asset-Liability Mismatch)
NBFCs fund their long-term loans with short-term borrowings from banks and other sources. This creates an asset-liability mismatch, as the long-term loans are illiquid and cannot be easily converted into cash to repay the short-term borrowings. In case of a liquidity crunch, NBFCs are unable to repay their short-term liabilities, leading to a crisis.
2. Interconnectedness between various NBFCs
NBFCs often lend to each other or borrow from each other to maintain liquidity. If one NBFC faces a liquidity crisis, it can trigger a chain reaction, as other NBFCs may also face difficulty in meeting their obligations.
3. Huge Exposure to Long-term Assets
NBFCs often have a high exposure to long-term assets such as real estate, infrastructure, and other projects. These assets are illiquid and cannot be easily sold to raise funds in case of a liquidity crunch. Moreover, if the value of these assets declines, it can lead to losses for the NBFC, further exacerbating the liquidity crisis.
4. Other Factors
Apart from the above factors, there are several other reasons that can lead to a liquidity crisis in NBFCs, such as:
- Weak corporate governance and risk management practices
- Over-reliance on short-term borrowings
- Poor credit quality of borrowers
- Deteriorating economic conditions
Conclusion:
The liquidity crisis in NBFCs is a complex issue that requires a multi-pronged approach. The government and regulators need to take steps to address the asset-liability mismatch, reduce interconnectedness between NBFCs, and strengthen risk management practices. Moreover, NBFCs need to diversify their funding sources, improve their credit risk assessment, and adopt better corporate governance practices.
1. Short-term Liabilities (Asset-Liability Mismatch)
NBFCs fund their long-term loans with short-term borrowings from banks and other sources. This creates an asset-liability mismatch, as the long-term loans are illiquid and cannot be easily converted into cash to repay the short-term borrowings. In case of a liquidity crunch, NBFCs are unable to repay their short-term liabilities, leading to a crisis.
2. Interconnectedness between various NBFCs
NBFCs often lend to each other or borrow from each other to maintain liquidity. If one NBFC faces a liquidity crisis, it can trigger a chain reaction, as other NBFCs may also face difficulty in meeting their obligations.
3. Huge Exposure to Long-term Assets
NBFCs often have a high exposure to long-term assets such as real estate, infrastructure, and other projects. These assets are illiquid and cannot be easily sold to raise funds in case of a liquidity crunch. Moreover, if the value of these assets declines, it can lead to losses for the NBFC, further exacerbating the liquidity crisis.
4. Other Factors
Apart from the above factors, there are several other reasons that can lead to a liquidity crisis in NBFCs, such as:
- Weak corporate governance and risk management practices
- Over-reliance on short-term borrowings
- Poor credit quality of borrowers
- Deteriorating economic conditions
Conclusion:
The liquidity crisis in NBFCs is a complex issue that requires a multi-pronged approach. The government and regulators need to take steps to address the asset-liability mismatch, reduce interconnectedness between NBFCs, and strengthen risk management practices. Moreover, NBFCs need to diversify their funding sources, improve their credit risk assessment, and adopt better corporate governance practices.
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Which of the following is the reason for NBFC liquidity crisis ?a)Short term liabilities (asset-liability mismatch)b)Interconnectedness between various NBFCsc)Huge exposure to long term assetsd)All of the aboveCorrect answer is option 'D'. Can you explain this answer?
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