8.

Key Issues and Current trends for NBFC Industry

Higher Borrowing from banks

NBFC
Borrowing cost of funds for NBFCs continues to remain high as the proportion of bank
funding in the overall borrowings of NBFCs remains high coupled with high levels of bank
base rates during FY2013. Credit to Non Banking Financial Companies (NBFCs) increased
by 26.6% in September 2013 as compared with the increase of 28.4% in September 2012.

Uncertainty about retail Non-convertible debentures

The cost of funding of NBFCs also has been impacted by the RBI guidelines on funds raised
by NBFCs through private placements of debentures, which capped the maximum number of
investors to 49 for private placement issuances. Additionally, RBI has set the minimum
subscription amount for a single investor to be Rs 25 lakh and in multiple of Rs 10 lakh
thereafter. Further, the guidelines highlighted that the money raised by NBFCs through
debentures should be used by themselves and not be used as resource for other group or
parent firms.
These guidelines have impacted NBFCs, as they substitute their retail fund mobilization
from the private placement route to the more costly bank borrowing/ public issue route
(where costs are estimated to be higher by 50-100 bps) depending upon the individual
NBFC's proportion of retail private placements and the proportion of outstanding retail
private placement debentures falling due for repayment over the next 12 months.

Dull Commercial Paper market

The Commercial Paper market is going through a dull phase, in line with the current
downturn in the economy. This has increased the funding challenges for NBFCs. Ideally, an
NBFC should be able to raise 1/3rd of its liabilities from retail, 1/3rd from banks and 1/3rd
from CPs and institutional placements. In the present scenario, given the move to put the
squeeze on NCDs and given the dull CP market, NBFCs have ended up increasing their
A Study on Non Banking Financial Companies in India

dependence on banks, which definitely not a positive sign as the Reserve Bank of India
(RBI) has excluded loans given by banks to non-Banking finance companies from the
priority list.

Return On Equity

The return on equity for non-bank finance companies (NBFCs) could dip to single digits, if
no transition period is offered to these entities by the Reserve Bank of India (RBI) for new
banks to comply with the priority sector lending requirement of 40%. However, if newly
converted NBFC is exempted from the priority sector norms, ROE may drop to only 13%
from the present original ROE of 16-17% (current average).
In the draft guidelines for licensing of new banks in the private sector, RBI has outlined that
the new banks should comply with the priority sector lending targets and sub-targets as
applicable to the existing domestic banks. Currently, domestic banks are required to lend
40% of their advances to certain segments such as agriculture, small business, retail traders,
professionals and self-employed individuals.

Slowing credit demand

Non-banking finance companies (NBFCs) are witnessing a slow growth in retail credit due
to a significant slowdown in the key segments, like construction equipment, commercial
vehicle and gold, which constitute around 56% of NBFC's total retail credit. This slowdown
is expected to have some pressure on asset quality and margins.

Prevailing macro-economic uncertainty

The macroeconomic uncertainty affects the cross-sectional distribution patterns of NBFCs.

As slowdown in the economy increases the risk of default and restructuring of loans can
increase, which could further lead to a deterioration of asset quality. Currently, the economy
is in doldrums with a little more than four year low Gross Domestic Production (GDP)
growth of 4.8% in July-September quarter and contracting Index of industrial production
(IIP) growth for October. Thus, with this significant slowdown in Indian economy, NBFCs
A Study on Non Banking Financial Companies in India

are encountering structural challenges such as increased refinancing risk, short-term assetliability mismatch leading to decelerating growth and declining margins, which is expected
to have a bearing on the profitability of NBFCs in the medium term.

Tighter regulatory norms for Indian NBFC

Official policies relating to NBFCs in general and gold loan NBFCs in particular, have been
prone to knee-jerk reactions for Indian NBFC sector, thereby affecting the stability of the
sector and denting investors' confidence.

8.1 Strategies for NBFCs

The distribution reach of some NBFCs is much superior to many banks

NBFCs have significant strengths in niche areas and enjoy very good customer relationships
in specific segments. They also have high brand equity in specific geographical areas. For
example, Sundaram Finance and Cholamandalam Finance have a very strong presence in
South India and continue to enjoy leadership position in commercial vehicle finance segment
due to their strong rapport with their customer base.
NBFCs, with their lean and mean structure, are more innovative and offer better flexibility.
Due to this they are able to attract a premium. For example, they have pioneered financing of
second-hand vehicles and built a strong presence in that segment. This sector also offers a
higher net IRR compared to new vehicle segment provided the company has prudent risk
management practices in place.

Consolidation in the sector

There was consolidation in the primary retail financing segments and many smaller NBFCs
have lost share to larger players. Some of the smaller players have become direct selling
agents and concentrated on originating portfolios for the larger players.

A Study on Non Banking Financial Companies in India

Lower overheads

NBFCs always enjoyed a lean and mean structure and when the sector came under pressure,
good players have maintained strict control over their overheads. This coupled with a
marginal increase in fee income has helped improve their profitability.

8.2 The Strategic Positioning of NBFCs

Positioning based on Products and Services

NBFCs have an edge over other players in products and services that require strong
customer relationships and service such as personal loans, commercial vehicle finance,
syndication services, inter-corporate deposits etc. In fact, technological developments such
as ATM networks, internet banking etc. have made banks more impersonal which increased
the advantage of NBFCs. Hence, it is possible for NBFCs to achieve a unique position by
focusing on certain category of products and services. Take the example of GE Capital
Services India (GECSI). It is primarily engaged in corporate asset funding through large
ticket term lending, hire purchase, leasing and bill discounting. Its foray into retail lending is
done through two separate subsidiaries. By focusing on large ticket corporate assets based on
its parenting advantage it has positioned itself away from most NBFCs and carved out a
niche for itself.

Positioning based on Customer Needs

NBFCs can also position themselves differently based on the differing needs of groups of
customers. This can be done successfully if a company has unique strengths to service a set
of customer needs better than others. The best example is Sundaram Finance (See Box). At a
time when the focus was on financing large truck operators, Sundaram Finance started off by
showing its commitment to and passion for the small truck operators. Gradually it built
strong relationships with truck operators and emerged as a leading financier of the transport
sector. Devoting its services to the growth of the road transport industry, Sundaram Finance
is today synonymous with automotive financing in the country
A Study on Non Banking Financial Companies in India

8.3 Growth Rate Statistics

I.

Balance Sheet Growth

NBFC sector clocked phenomenal growth in the last ten years. The sector on an average,
witnessed a Compound Annual Growth Rate (CAGR) of 22 per cent during the period
between March 2006 and March 2013.
NBFC sector exhibited counter cyclical movements in 2011-12. In other words, NBFC
sector clocked a growth of 25.7 per cent in 2011-12 although GDP growth decelerated to 6.3
per cent in 2011-12 from 10.5 per cent in 2010-11.

II.

Credit Growth
Credit growth across NBFC and banking sectors is presented in Chart 4. NBFC - credit grew
more rapidly as compared with the banking sector. NBFC credit witnessed a CAGR of 24.3
per cent during the period between March 2007 and March 2013 as against 21.4 per cent by
the banking sector.

Although Indian economy is slowing down in the recent past, the robust NBFC credit growth
is largely on account of significant growth in infrastructure credit and retail finance.

A Study on Non Banking Financial Companies in India

III.

Financing of Infrastructure

By financing infrastructure projects, NBFCs broaden capital formation of the country and
thereby contribute to the overall economic growth and development of the country. The
quantum of infrastructure finance provided by the NBFC sector witnessed a CAGR of 26.2
per cent during the period between March 31, 2010 and March 31, 2013.

In absolute terms, NBFC finance to infrastructure increased from Rs.2228 billion on March
31, 2010 to Rs. 4479 billion as on March 31, 2013 (Chart 4A). NBFC finance to
infrastructure accounted for 35.8 % of their assets as on March 31, 2013 while in case of
banks it was 7.6%.

A Study on Non Banking Financial Companies in India

IV.

Public Deposits

In line with RBI directions, the public deposits of NBFC sector (including RNBCs) declined
considerably from Rs. 247 billion as on March 2007 to Rs.106 billion as on March 2013
(Chart 5).

The decline in public deposits is largely on account of RNBCs, which are going to exit from
NBFC business model by June 2015. The public deposits of RNBCs decreased from Rs. 202
billion as on March 31, 2007 to just Rs. 35 billion as on March 31, 2013.

V.

Micro Finance Institutions

NBFC-MFIs provide access to basic financial services such as loans, savings, money transfer
services, micro-insurance etc. to poor people and attempt to fill the void left between the
mainstream commercial banks and money lenders.

Over the last few years NBFC-MFIs have emerged as a fast growing enablers in providing
the financial services to the poor people by providing capital inputs to poor which generates
self-employment, and thereby promotes inclusive growth.

A Study on Non Banking Financial Companies in India

The credit provided by the NBFCs - MFIs11 increased from just Rs. 105 billion as on March
2010 to Rs.151 billion as on March 2011 and declined to Rs.117billion on account of the
ordinance passed by the AP Government that stopped all MFIs from collecting payments by
force or even disbursing loans by the MFIs. However, in March 2013, the outstanding credit
disbursed by the MFIs increased to Rs.144 billion due to partial resumption of MFI activities,
owing to implementation of the Malegam Committee recommendations and certain Supreme
Court orders favorable for MFIs.

To encourage MFIs, as per the Malegam committee recommendations, RBI has created
separate category under NBFCs. As on date, around 33 MFIs have been registered with RBI.

VI.

Monetization of Gold

Gold loan NBFCs provide loans against security of gold jewellery. Although banks are also
involved in gold loan business, NBFCs gold loans witnessed phenomenal growth due to
their customer friendly approaches like simplified sanction procedures, quick loan disbursement
etc.

Branches of gold loan NBFCs increased significantly during the last couple of years mostly
housed at semi-urban and rural centers of the country.

Gold loan NBFCs help in monetization of idle gold stocks in the country and facilitate in
creating productive resources. Credit extended by the gold loan NBFCs witnessed a CAGR of
A Study on Non Banking Financial Companies in India

86.7 per cent during the period March 2009 to March 2013. In absolute terms, NBFC gold loans
increased from just Rs. 39 billion as on March 31, 2009 to Rs.475 billion as on March 31, 2013.

To study the issues related to the gold loans by NBFCs a working group was set up under the
chairman ship of K.U.B. Rao which submitted its report in January 2013. Several
recommendations have since been accepted and acted upon.

VII.

Second Hand Vehicle Financing

NBFCs also engage in financing used/ second hand vehicles, reconditioned vehicle, threewheelers, construction equipment besides secured/unsecured working capital financing etc.

Incidentally, in India except NBFCs no other financial sector player finance second hand
vehicles; which are very popular with road transport operators essentially in the self-employed
segment.

A Study on Non Banking Financial Companies in India

VIII.

Affordable Housing

Another area where NBFCs are participating in the inclusive growth agenda is affordable
housing. Large NBFCs are setting up units to extend small-ticket loans to home buyers targeting
low-income customers across the country. Firms are offering loans of Rs. 2-6 lakh to borrowers
with monthly income of Rs.6000 12000 who find it difficult to borrow from the commercial
banks. Firms offer easier know-your customer (KYC) norms such as relaxation in documentation
requirements to facilitate easy access to low-income borrowers. The trends in housing loans
provided by the Housing Finance NBFCs are furnished below.

Housing finance NBFCs are real game changers in terms of providing housing loans at par with
Public Sector Banks (PSB). The quantum of housing loans provided by the housing finance
NBFCs is almost the same although they are comparatively far smaller than PSBs (Chart 13).

A Study on Non Banking Financial Companies in India

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