Whatever happened to NBFCs
NBFCs are an integral part of economy that provides easier access to credit and hence help in attaining aggressive growth. But that also makes them vulnerable as any slowdown in the economy hits them hard first. Let us try to analyse the business sense of these NBFCs and arrive at the scenario of Indian NBFCs.
In this post, I have tried to make an analysis of Indian NBFCs yesterday, today and tomorrow.
NBFC – a brief introduction
NBFC stands for Non Banking Financial Company. These are money lending institutions that are much more agile than traditional banks. They are agile in the sense that the credit line extended is much deeper and aggressive than normal banks. Other advantages of NBFCs are that they are extremely quick at processing and accomodate riskier profiles in their portfolio. And since they take more risks, they get their cushion in the form of higher interest rates. Yes, they charge higher interest rates than what normally banks charge. This also has to be viewed in the context that the acquisition cost of funds for NBFCs come at a higher cost than banks, the details of which we will explore further below.
Lending and Credit
Before delving deep into the subject of NBFCs, it is important to understand how credit extension and growth of a country are interlinked. Most of the business operations are financed by lending institutions. Banks form a major chunk of providing funds to these companies. This is evident from the fact that more than 50% of credit portfolio of State Bank of India is through corporate lending. These funds are required to meet varied requirements like day-to-day operations, capital expansion, business consolidation, etc. For most of the small and medium sized businesses, access to aggressive credit from banks is unthinkable. These businesses usually turn to such non-banking finance companies for gaining access to credit. More credits to businesses means more growth when things go fine. Thus along with growth numbers of these companies, the GDP index also climbs up. But if the going gets tough, then defaults go on the rise. This is when the risks taken by these NBFCs start showing its naked face. As the defaults rise, to stay on the NBFCs naturally would tighten the valves and rework their risk model to flush out riskier profiles. Access to credits become tougher and businesses shutdown leading to job cuts. Hence the production comes down and consequently the GDP numbers take a hit. It is not as straight-forward as explained here but I have tried to provide a simple explanation of what happens in large scale.
List of popular NBFCs in India
- Shriram City Union Finance
- Sundaram Finance
- AIG Consumer Finance
- Reliance Consumer Finance
- Citi Financial
- DBS Cholamandalam Consumer Finance
- Indiabulls Financial Services
- and others
NBFCs Yesterday
For the past five years, the indian economy was promising on all aspects and with money from foreign investors pouring in, large pool of investments were created through mutual funds. These mutual funds have been the primary source of funds for NBFCs. As there was excessive inflow of money, borrowing from mutual funds was cheaper then. A bunch of above mentioned NBFCs mushroomed during this period to ride on such a promising opportunity. With indian banks remaining as conservative as ever (partly due to government regulations), and natural greed of mutual funds, NBFCs were nothing less than celebrating. Many other small NBFCs have also been started within a short span of five years. An Increasing number of microfinance institutions (MFIs) were also seeking non-banking finance company (NBFC) status from RBI to get wide access to funding, including bank finance. As the weather was fine and the government was poised to attain aggressive GDP growth, nothing could have stopped these NBFCs from posting tremendous growth. NBFCs have been accounting for as much as 30% of the retail lending sector where the only other aggressive lender among banks is ICICI Bank. Well, the world was about to receive one of the greatest shocks of this century that would threaten the world economy to bring it to a grinding halt.
NBFCs today
As of the time I am writing this article, most of the NBFCs that have mushroomed during the last five years have either shutdown their shops or have stopped providing credit for the time being. Yes, they have come to a stand-still. Why did this happen all of a sudden? The reason is very simple. All these NBFCs have been relying on Mutual Funds to provide them with access to capital. But as the global economy was facing turmoil, mutual funds were profusely bleeding under redemption pressure. With capital drying up and banks refusing to lend any money at all to these institutions, NBFCs could no longer stay afloat. Atleast, these institutions no longer provide any unsecured loans like personal loans and they dont have the money to provide home loans.
NBFCs tomorrow
As it is, the indian situation is not so bad. Tough regulations and inherent conservativeness have come as a blessing in disguise. Except for the exposure of ICICI Bank, all the other banks were pretty much safe from the global turmoil. Although the stock markets bled and the government reduced the GDP growth forecast, India is in a comfortable zone. RBIs recent moves aimed towards increased liquidity in the economy ahs more than made up for the void created by withdrawing FIIs. This is an extremely valuable learning for the Indian economy as to what should be the dependence on FII money. RBI has not just provided liquidity in the system by releasing funds of banks, it also has opened up gates for NBFCs. RBI has allocated nearly 40000 crores that can be borrowed by NBFCs. This is only a fraction of what NBFCs were accounting for the sector, that is nearly 30%. In just plain numbers, NBFCs non-deposit taking is Rs 3,80,000 crores. Thus its not a long term solution provided by RBI, but a short term measure that is just enough to keep the NBFCs afloat.
In the long term, as said by CRISIL, these institutions would have to change their business model with strong focus on product innovation and a move towards the originate-and-sell model.
Other interesting articles that covers the state of affairs of NBFCs in India
