NBFC operating model key to reducing risks

A comprehensive and pragmatic view of the risk and finance functions is necessary

For the past month or so, concerns are being raised on liquidity challenges and the possible asset liability mismatches (ALM) in the non-banking financial companies (NBFC) space. Many of the top NBFCs have lost their sheen on the stock market and may face challenges in raising/renewal of funds, given 41 per cent of the borrowings of NBFCs are maturing in the next six months.
 
NBFCs have had phenomenal asset growth (average annual growth rate of 22 per cent) for the last few years. The size of the NBFC sector in India was about Rs 27.5 trillion in 2017 in terms of asset base. The growth has increased on the backdrop of commercial banks’ reluctance in taking further exposure to the corporate sector, given that most of them are already grappling with asset quality issues. The NBFC growth in assets is supported by funds raised mainly through issuing debentures and CP, and borrowing from banks. The NBFC borrowings, through debentures and commercial papers (CPs), have been on the rise in the last four years. The share of debentures and CPs together accounted for over 41 per cent in the resource mix of NBFCs (non-deposit taking) at the end of 2017.    
     
However, there is a reversal of the interest rate cycle, as rates are now inching up in the domestic market due to inflation fears and a weak currency. NBFCs have started feeling the pinch. To reduce the cost of borrowings and continue to be competitive, many have moved towards short term funds like CPs that has witnessed relatively less hike in yield.  This is where the challenge lies. This has now created an ALM, where shorter tenure funds up to one year, are being used to finance long-term assets (like housing finance, infra loans etc). This has, in turn, brought instability on funding as the roll-over risks are increasing, since the risk perception of NBFCs have increased in the market.  
 

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With the current higher risk perceptions on NBFCs sector and expected new regulatory changes in particular, modified ALM and liquidity management – NBFCs will have to incur higher costs associated with infrastructure for risk and finance functions and increased stress on timely reporting. It is time for NBFCs to re-look at their operating model in particular the risk and finance support functions and minimise the duplications.
 
Risk and finance alignment is a conscious, organised way of more closely linking some, but not all, elements of both the risk and finance functions. It requires a comprehensive and pragmatic view of the risk and finance functions, especially from the point of view of data management, organisation and governance, process, technology, and standards and definition.
 
It will also require resolving the differences between two functions that have fundamentally different cultures. The alignment will lead to numerous benefits include greater cost savings, improved controls, greater transparency, the ability to make better business decisions and improved compliance with regulatory mandates.
 
The next step should be determine the target operating model (TOM) indicating what the alignment of risk and finance should look like for their organisation.
 
The TOM should also address the coordination necessary with other functions, such as IT and operations. This will help implement alignment in a way that advances long-term strategic business goals and promotes compliance with mandated near-term regulatory and internal initiatives on limit management.
 
NBFCs, being financial intermediaries, are engaged in the activity of bringing the investing and borrowing community together.
 
In this role, they are perceived to be playing a complimentary role to the banks rather than being their competitors. The need of the hour is to focus on addressing the alignment of business and risk goals through an improved operating model, which will help them limit and manage business risks.