Change The Name And Then The Game

Calling these intermediaries by a name that defies definition is itself a hinderance in the path of supervision and regulation. Though within this generic name, there are categories and sub-divisions, ultimately it will be difficult to regulate a financial company which has no clear objective or direction.

Such a categorisation may have been acceptable in the eighties when these financial intermediaries started springing up. The banking system was bound by regulations, weighed down by norms and the compartmentalisation of credit. This lack of competitive forces made most banks staid and unwilling to fill gaps in the market place.

In such a situation, NBFCs came into being, eager to exploit the inefficiencies of the market and exploit gaps in the market for funding corporates and retail customers. So they began to discount bills for companies, advise firms on treasury management and fund assets through leases, hire-purchases and short-term loans.

 

But these gaps which had opened up have been gradually closed over the past four years. Banks have become more pro-active in funding companies.New banks, domestic and foreign, have also entered the market and began offering fund-based services similar to that of NBFCs but at a lower cost, especially in segments like car finance and personal hire-purchase loans.

For quite a while, this trend was ignored by the non-banking finance companies, as they were diverted by the rise and rise of the capital market, which brought with it opportunities for issue management, underwriting and bought-out deals. Some of this was done using money raised from public fixed deposits.

But as the size and scope of the primary capital market has shrunk and banks have gradually reclaimed their lost markets, finance companies slowly realise that they are inefficient in most of the businesses they are involved in. The smarter ones realise a need to focus on their strengths and exploit the competencies in those areas. Even the most diversified NBFC has realised that there is an urgent need to focus on specific business lines rather than try and be the jack of all trades.

This change in the market place and the reduced impact of the non-banking finance company as an funding intermediary has to be reflected in the way these entities are regulated.

Ideally, the Reserve Bank should scrap the concept of an NBFC and categorise the finance companies in line with their business activities. This would help in making sure that only those financing physical assets like cars, trucks, plant and machinery should be allowed to collect deposits. Others which under the guise of finance company are merely investment banks or securities brokers should have no access to the market for fixed deposits.

Categorising the firms in line with the type of business they engage in, also helps to regulate firms accordingly. It is foolish, for instance, to have the same degree of regulation for a firm which has no fixed deposits and engages in non-fund based activities like merchant banking or borrows from banks and institutions to finance its fund-based activities. Other firms, which borrow public money through NCDs or fixed deposits to finance machinery, cars or trucks should, however, be forced to enclose quarterly statements on the nature and quality of its asset book, which has been endorsed by an independent auditor.

Dividing the finance companies in this manner will force certain changes in the system. It will mean that investment banking division has to be clearly demarcated from the asset-finance wing of a company and the books have to be maintained separately to ensure that funds do not flow from one business to another. It will also help curb the practice of using borrowed funds for inter-group investments in broking and mutual fund subsidiaries.

On a very basic level, it will stop NBFCs from doing everything if the asset side of their balance sheet is controlled. And while some activities have to be financed by fixed deposit collections, others can be refinanced through the banking system. Lease and hire-purchase transactions for plant and machinery can be refinanced from the banking sector. So can other businesses like car loans, truck loans and home loans.

What regulations will also do is force the NBFCs to think more closely about their ability to survive. Depressed market conditions over the past year or two have already forced many to shut down their operations. The new rules on the basis of assets will allow the finance companies to exploit their main strength: their distribution and coll- ection facilities.

Those who do not have such capabilities will have to surrender their businesses to the banks, who are after all more cost efficient than the finance companies.

But all of this has to start with the scrapping of the name, non-bank finance company. Once it is known, what exactly these companies do, it may be easier to regulate them.