NBFCs

Big bucks for small players

Proper mechanisms need to be set up to ensure long term survival of NBFCs

With the global financial meltdown intensifying, Non-Banking Financial Companies (NBFCs) are facing a dilemma with respect to the sheer viability of their business model. These firms are finding it difficult to operate in an environment where money is scarce and defaults are more the norm than the exception. The golden period for NBFCs in India was during the 1990s when the country was experiencing a rapid industrial growth, thanks to the liberalisation policies of the early 1990s. But then, as it’s said, greed spares none! In their effort to grow at any cost, many smaller NBFCs ended up too weak to pay the then prevalent high interest rate, especially during the industrial slowdown of the late 1990s, thus marking the beginning of the end of the golden period. But then in 1998, the RBI came to their rescue and thanks to the stringent regulations for registration; many ‘fly-by-night’ NBFC firms got dismantled from the market.

The forte of these financial institutions is to serve the consumer not covered by traditional banks and financial institutions. Due to their unique business model, these firms were able to retain their customers for longer periods. In simple terms, they gave loans to people who were denied by other banks and thus made them their loyal customers.  

The current period, however, is seeing these NBFCs face a mammoth challenge yet again. In this Darwinian (survival of fittest) economy, it literally gets tough for small NBFCs to survive and challenge the big financial institutions when hostile winds start flowing. Many small NBFCs are opting for consolidation by mergers to address this problem and inverse the Darwin concept. However, many NBFCs are also trying to diversify their portfolio in order to tap new markets and give steep competition to traditional banking and financial institutions. They are extending their product portfolio and are entering into areas like asset management, housing finance and the insurance sector as well. Take, for instance, the case of Sundaram Finance, which has plunged into the housing loans market, challenging honchos like LIC Housing Finance. Even Kotak Mahindra Finance Limited and Lakshmi General Finance are considering the insurance business. Ashok Leyland Finance has gone one step ahead and is planning to sell products of other financial intermediaries as well and thus help in the diversification of the company’s revenue model.

Since NBFCs have low operating cost (compared to banks and other financial institutions) because of their small size, they do have an upper hand and thus can divert the benefits of the same to their customers. But in order to command the market and ensure a sustainable business model, NBFCs have to improve their service levels in terms of convenience and duration for loan disbursal.

As per a report published by Wharton   in 2007, there are 436 deposit-taking NBFCs in India, of which 16 have asset sizes of over Rs.5 billion and 2,615 non-deposit taking NBFCs, of which 104 have assets worth at least Rs.1 billion each. Most of the non-corporate sectors like retail, hotels and restaurants abhor the prospect of taking finance from private lenders where they end up paying higher interest rate. Most of new start-ups, immature businesspeople, transport companies and small service providers rely heavily on these small NBFCs. Since funds from NBFCs are available to these players without much paperwork unlike traditional banks, these non-corporate sectors readily opt for these lenders. This is where the role of NBFCs gets enhanced. These companies act as hassle free units/service providers for all those who are not able to meet stringent criteria and paper work of traditional financial institutions. Sometimes, these NBFCs come to the rescue of small village industries as Micro-Finance Institutions (MFIs). No doubt, if the domestic financial markets are integrated with NBFCs by making them channel partners, it would, to a large extent, solve the credit delivery problem of our economy. This would not be a one of its kind model. Presently, many countries including India are using NBFCs as channel partners.

This sector is highly fragmented and regulatory approvals in the case of NBFCs arrive faster compared to the time taken for receiving an approval for new banks. Moreover, as the banking sector is still not open, foreign banks are trying to come into the country via the NBFC route – after they get clearance from the Foreign Investment Promotion Board (which is much simpler than getting a nod from the RBI). Stringent compliance and regulations by RBI for NBFCs (especially domestic players) do not allow small players to come up with this service.

In fact, mostly big players are operating in the arena at the moment and they are serving the big honchos of the market (to reduce risk and to increase bottom line). Now, this is exactly contrarian to the fundamentals for which NBFCs (or MFIs) were opened. RBI should ensure that it makes a clear-cut demarcation so that NBFCs do not target customers of big banks and primarily serve their target audience only. Otherwise, SMEs will be left in the lurch.

It’s beyond any apprehension that NBFCs are playing an increasingly important role for the macro economic situation (providing finance to one and all) of India and for reforming the financial market. However, while letting NBFCs grow and take up the market, the regulators must ensure that only those institutions survive that are serious about being in the finance business and not some small chit-fund companies who end up being liabilities.

The concept of opting for NBFCs as channel partners by the traditional commercial financial institutions on a large scale would assist the sector in this extremely competitive market and allow them to fortify their presence among global players in the emerging financial market. Also, it would ensure that SMEs, which are so crucial to the Indian economy, are not deprived of much needed funds for growth.