NBFCs : Is the future bright ?

Shubhashish Dubey

Non Banking Financial Companies (NBFCs) in India were having golden days during 1990s. Their heady days were fueled with the rapid industrial growth due to liberalization in 1991, simple resource-raising regulations and eager & greedy investors ready to put their saving into any finance company. As has been said, when you have ample amount of something you do not care for it, NBFCs too have invested heavily but unwisely. Growth-at- any-cost was the strategies of some of the NBFCs. Moreover, due to this many weak NBFCs could not pay the hefty interest during the industrial slowdown during 1997 bringing to an end the golden period (or otherwise) of NBFCs.

The rating agencies downgraded many companies which was followed by the RBI tightening the resource raising and prudential norms in January 1998. It should be noted that during the 36-month period from April'97 to March'00, Crisil downgraded 149 NBFCs due to their deteriorating business and financial risk profiles and credit fundamentals. The stringent regulations, refusals for registration and the notifications regarding the cancellation of the permissions to raise deposits have gradually  reduced the fly-by-night operators. NBFCs are now struggling hard to find reasons for continued existence, strategies for such existence and business areas for growth and earnings.

Now the question before us is whether the NBFCs, which have traditionally dominated the market of retail finance (like bill discounting, ICDs financing and the car finance business), can meet the challenges of the future. If yes, then how and what should be the role of RBI and other regulatory authorities while governing the financial market.

The forte of NBFCs has been credit delivery to areas not covered by banks and financial institution(FIs). By virtue of there past experience NBFCs know the tacit needs of retail customers much better and with more sensitivity than others do. As traditional boundaries between different categories of financial intermediaries are disappearing, NBFCs have to face stiff competition in retail financing specially from banks and FIs. Does it mean that NBFCs should move into the forte of Financial intermediaries (i.e. working capital loans and term lending)? Given the fact that financial intermediary's business is dominated by the attendant risk and the banks' and top rung FIs' ability to raise funds at low cost, if NBFCs compete head-on, then they will be at loss owing to their high cost of mobilizing funds.

Though the evolutionary process of the NBFCs has made them nimble and agile, their main handicap is the small size of their balance sheet, resources and their distribution reach, which is region specific. The limited cushion available to them in times of difficulties pose a great threat to their very survival and restrict their opportunities to grow. The biggest challenge in front of NBFCs therefore is to increase their size. This could be by merging with each other.

There is just not place enough for so many small micro NBFCs. Therefore, those who still try to hang on without concrete plans or core strengths, are bound to die a very painful death. The newer layers are likely to bring in tremendous financial muscle. In the take-off period, they can afford to be over aggressive and their product sophistication is also likely to be superior.

Given such a situation, NBFCs must realize the plain fact that a certain amount of market share and size or a "critical mass" is vital for sheer survival. The NBFCs, in the next couple of years, will be faced with the relentless logic of Darwinism. A process of elimination is certain.

But a financial intermediary cannot be closed down like a cement plant or a soap factory as they have a set of financial claims both inward and outward with differing maturities and risks. So the most practical method would be consolidation by mergers. World over, troubled banks and non- banks have been bailed out by the mergers and acquisition route. This is apart from the numerous mergers done on purely commercial considerations. Their should therefore be a call for immediate measures to facilitate mergers of NBFCs with ``profitable'' companies to avoid the risk of default in repayment of public deposits, bank, institutional funding and to make NBFCs grow in future.

Apart from mergers, other options waiting for NBFCs are to change the tracks and explore new areas. They have to extend their product portfolio to include asset management companies, housing finance firms and to venture into newly opened insurance sector for private participation. Examples of such initiatives are launch of associate company of Sundaram Finance to disburse housing loans, which has been the domain of HDFC and LIC Housing Finance. Entry of Kotak Mahindra Finance Limited, Sundaram Finance and Lakshmi General Finance into the insurance business is another example. In the medium term most NBFC's are looking at developing niche areas and concentrating on fee based income to offset the loss in fund based activities. Examples include the move of Ashok Leyland Finance to launch a finance portal that would be used to sell products of other financial intermediaries and to use its skill in collection to derive a pure service income. The benefits of such horizontal integration would be a diversification of the company's revenue stream which goes with the old saying of putting one's egg in different baskets.

Another new area which can be explored by NBFCs is the Internet. Recently the Morgan Stanley Dean Witter Internet research emphasized that Web is more important for retail financial services than for many other industries. Web based services involve use of Internet for delivery of financial products & services. The Internet has leveled the playing field and afforded open access to customers in the global marketplace. Internet financing could be a cost-effective delivery channel for NBFCs.

In the market of retail finance and financial loans, in order to beat the competition, NBFCs have to increase the quality of their service which is described as the convenience offered to the customer in terms of speed, accuracy and product features. Investors in future will also be looking for certain qualitative details like reputation of the management and the financial track record of the NBFC before they invest their monies. NBFCs stands a good chance to succeed as they have an advantage of being lower in operating cost as compared with other financial intermediaries because of their small size, efficient operation and fast decision making. NBFC's aggressive collection mechanism and lower proportion of big corporate loans gives them an edge in containing risk and also results in less amount of NPAs which is critical in the financial sector.

RBI and other regulatory authorities have a very important role, if NBFCs have to deliver their cause. After strengthening of the regulatory framework in 1997, the mushrooming of NBFCs has slowed down and the RBI has been releasing the lists of companies which have been refused registration to caution the public. The authorities need to review the legislation and provide for punitive penalties for any unit mobilizing deposits without registration. To protect individual deposits held by NBFCs, the RBI have to tighten operating norms governing their operations.

However, the thrust of policy should be to relax its newly implemented regulatory framework and increase the amount of funds which equipment and leasing companies can raise as public deposits for the NBFC which are performing consistently well. The credit rating norms should also be relaxed. Apart from these measures their should be some incentives to the well managed NBFCs by giving them opportunity to become banks and by setting out very reasonable final guidelines for entry of NBFCs into insurance and other areas. Some other measures like eased guidelines for foreign investment in NBFCs as was done by the Finance Ministry on March 27th should be initiated. A holding company can now set up a wholly owned NBFC subsidiary with a minimum capital of US$5m, compared with an earlier minimum of US$50m.

The role of NBFCs has become increasingly important from both the macro economic perspective and the structure of the Indian financial system. Over a period of time, one has to accept, that it is only those which are big enough and serious about being in the finance business will and must grow. Scamsters must get exemplary punishment. To survive and constantly grow, NBFCs have to focus on their core strengths while improving on weaknesses. They have to constantly search for new products and services in order to remain competitive. The coming years will be testing ground for the NBFCs and only those who will face the challenge and prove themselves will survive in the long run.


Shubhashish Dubey is a Student at Management Development Institute (MDI), Gurgaon
Uploaded on February 8, 2001

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