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Shares of non-banking finance companies like IDFC and LIC Housing Finance have shot up after the Election Commission cleared Reserve Bank of India’s (RBI) proposal to issue new banking licences. Investors anticipating a new growth avenue for these companies have taken the stocks higher.
There is no doubt a banking licence can change the fortunes of these companies. However, it' s still early days for these companies to derive any financial benefits from these ventures. In fact since they will be mainly in the investment mode over the next few years, profits of these companies would be dented.
Analysts have started questioning the valuations of companies that have recently run up saying that fundamentals do not justify the recent run-up. Moreover, the reasons cited by Mahindra and Mahindra Financial Services to exit the race due to RBI norms not being conducive for large and successful non-banking finance companies (NBFCs) also needs to be weighed.
Markets generally tend to discount an event well before it has occurred and at times taking prices to an extreme. At such times, it is always better to read the fine print to get a reality check. Following are five things an investor needs to know while investing in companies likely to get a banking licence.
1. Regulatory hurdles:
After bringing in a minimum of Rs 500 crore as equity capital, new banks will have to meet CRR (Cash Reserve Ratio) and SLR (Statutory Liquidity Ratio) requirement from day one. In other words, a sizeable amount of capital and low cost deposits of these NBFCs will be earning minimal returns. Despite lower cost of capital on account of access to current and saving banks, blocking of money on account of these provisions have impacted net interest margins (NIM) of banks. NIM of Shriram Transport is between 6-7 per cent while that of banks is around 3-4 per cent (better ones). Thus investors will have to get used to lower profitability.
After bringing in a minimum of Rs 500 crore as equity capital, new banks will have to meet CRR (Cash Reserve Ratio) and SLR (Statutory Liquidity Ratio) requirement from day one. In other words, a sizeable amount of capital and low cost deposits of these NBFCs will be earning minimal returns. Despite lower cost of capital on account of access to current and saving banks, blocking of money on account of these provisions have impacted net interest margins (NIM) of banks. NIM of Shriram Transport is between 6-7 per cent while that of banks is around 3-4 per cent (better ones). Thus investors will have to get used to lower profitability.
2. Financial inclusion and priority sector lending:
NBFCs will have to open branches in unbanked areas and compulsorily lend money to some of the riskiest assets, which they are currently not exposed to. The guidelines require new banks to open 25 per cent of their branches in unbanked rural centres.In other words in places where even public sector banks have not reached.
NBFCs will have to open branches in unbanked areas and compulsorily lend money to some of the riskiest assets, which they are currently not exposed to. The guidelines require new banks to open 25 per cent of their branches in unbanked rural centres.In other words in places where even public sector banks have not reached.
3. Consolidation of operations:
Most of the NBFCs which are expecting to get a banking licence have strong balance sheet with high NIMs. Lower profitability in initial years can raise anxiety levels of investors.
Most of the NBFCs which are expecting to get a banking licence have strong balance sheet with high NIMs. Lower profitability in initial years can raise anxiety levels of investors.
4. Increased competition:
RBI governor has said that banking licence going forward will be available on tap. This will not only increase competition in the sector, especially in the most lucrative markets but also increase cost of operations on account of prime real estate and high cost top performers.
RBI governor has said that banking licence going forward will be available on tap. This will not only increase competition in the sector, especially in the most lucrative markets but also increase cost of operations on account of prime real estate and high cost top performers.
5. Competing business interests:
A NBFC normally competes with a bank for a client. Even after charging higher interest rates, NBFCs have managed to grow only by taking riskier clients and following strict recovery norms. These NBFCs will now have to compete with itself in offering banking rates to clients a bank would have otherwise refused. Diverting banking clients to NBFCs could raise regulatory issues.
A NBFC normally competes with a bank for a client. Even after charging higher interest rates, NBFCs have managed to grow only by taking riskier clients and following strict recovery norms. These NBFCs will now have to compete with itself in offering banking rates to clients a bank would have otherwise refused. Diverting banking clients to NBFCs could raise regulatory issues.
