NBFCs are key to India's growth story

The sector has played a critical role in the development of infrastructure, transport and the support system for economically weaker sections

Remember the days when moneylenders were charging exorbitant interest rates and dictating terms to the borrower despite having all the security in place? Unlicensed moneylenders used to inhabit the rural neighbourhood without any regulation, leading to pricing inefficiencies. Spotting an opportunity, chit fund companies (regulated by states) and Nidhi companies (regulated by the Ministry of Commerce) also mushroomed. For the past decade or so we have seen that space being occupied by the Reserve Bank of India (RBI)-regulated non-banking financial companies (NBFCs) aiming to bridge the gap in pricing inefficiency based on perceived risk. NBFCs largely depend on market based funds.

Recent events triggered pandemonium among a few of its participants, precipitating a contagion effect. Not only did the money markets witness volatile yields, the trouble spread to the stock markets with prices reacting adversely. The strong finance companies stood out during the mayhem. For example, the price to earnings multiple (PE) for 133 actively-traded NSE-listed finance companies stood at 21.9x and the price to book value multiple (P/BV) at 2.7x. Sub-sectors such as investments and medium-sized finance companies command PE of more than 30x. Going forward, any incremental lending resources released either through regulatory measures or government infusion would find efficient fund allocation among competing asset classes including finance companies.

Following the crisis, the NBFC sector was compared with shadow banking in India. However, it might be naïve to draw such a comparison. The size of the NBFC sector in India is around $0.4 trillion with a share of only 0.9 per cent in the global shadow banking space. In contrast, in China it has ballooned to at least a $7 trillion business involving financial institutions. If one compares this ecosystem with NBFCs in India, there is hardly any parallel. Even in small jurisdictions such as Cayman Islands and Luxembourg the size of shadow banks is much larger than that in India. NBFCs in India are also RBI/Sebi regulated. The RBI has been quite farsighted in slowly migrating NBFCs to a Basel-like prudential regime structure.

As of March’18, there were 11,402 NBFCs registered with the RBI, of which 156 were deposit accepting (NBFCs-D). There were 249 systemically important non-deposit accepting NBFCs (NBFCs ND-SI). The aggregate balance sheet size of the NBFC sector as on March 2018 was Rs 22.1 trillion (around 15 per cent of the banking system balance sheet size). The financial performance of NBFCs-D has been quite impressive. Their assets size has increased by 21.8 per cent (CAGR) in five years while their loans and advances have increased by 27.7 per cent (five-year CAGR).

The contribution of NBFCs is key to India’s growth. These companies played a critical role in the core development of infrastructure, transport, employment generation, wealth creation opportunities and financial support for economically weaker sections; they also make a huge contribution to the state exchequer. 

NBFCs also provide an alternative source of funding and liquidity. Non-bank entities with specialised expertise provide an alternative source of credit and certain functions in the credit intermediation chain more cost-efficiently. As such, NBFCs represent a unique success story in financial innovation and last mile connectivity. They have even succeeded in pockets where banks have not been able to reach. 

What next? Under the circumstances, it is imperative that we continue supporting NBFCs and keep the financial system flush with adequate liquidity. A combination of mid-course corrections on the part of NBFCs themselves and regulatory changes in the interregnum could also be positives for this sector.

  

Finance companies need to be asset light so that they can improve their return on equity (RoE). Some of the investment and small finance companies have a large fixed asset base (including capital work in progress). Asset heavy companies that have low yielding assets may now pursue an asset light model. In fact, emphasis on consolidated numbers, namely, financials, quality of receivables, RoE, cash flow from operations, portfolio mix and asset and liability management (ALM) remain key factors from a stakeholder’s perspective.

From the regulatory perspective, NBFCs are subjected to prudential regulations. As an example, ALM needs to be straightened and a holistic touch in sub-sectors such as housing finance could be an ideal regulatory intervention. 

Overall, NBFCs, still are a valuable alternative and can hardly be ignored. Except perception, nothing much has changed in the financials of the sector. It is imperative that NBFCs are supported whole-heartedly in this hour of reckoning. 

The author is DMD & CFO, State Bank of India. Views are personal