NBFC Market Research and Strategic Opportunity

A Non-Banking Financial Company (NBFC) is a non-banking institution and has principal business of receiving deposits under any scheme or arrangement in one lump sum or in instalments.

Role of NBFCs in financial services

Problem areas and challenges

Effect of COVID-19 pandemic

Financial Performance of NBFCs

● NIM: Net Interest Margin of NBFCs was 5.7% in 2021 compared to 3.2% for banks

● RoA: RoA was over 5% for NBFCs in 2021 compared to 0.7% for scheduled commercial banks

● NPA: Gross non-performing assets were at 6.2% for NBFCs, compared to 5.9% for scheduled commercial banks.

Key Financial Parameters of banks and non-bank lenders

Source: RBI, NHB, EY Analysis

Exhibit 6: Trend in Asset quality of banks and non-bank lenders

Source: RBI, NHB, EY Analysis. Note: Non-bank lenders transitioned to 90dpd NPA recognition starting FY18 from 180dpd in FY15

Profitability of NBFC Sector (Deposit Taking and NDSI)

Data source- Supervisory Returns, RBI

Industry Size and Growth

Outstanding credit and customers: Non-bank lenders constitute about ~25% (over INR 35.9 lakh crore as on Sept-2019) of the systemic credit outstanding and have financed over 10 crore customers drawing strength from their extensive footprint largely in rural and semi- urban areas (~70% of total branches). NBFC — INR 23.5 lakh crore and HFC — INR 12.4 lakh crore

New credit proportion: Non-bank lenders have dominated the sourcing of ‘New to Credit’ customers accounting for over 50% of incremental credit flow to this segment across geographies.

Loan origination in rural/sub-urban areas: Non-bank lenders fill the vacuum created by private banks in rural/ semi-urban India and account for one-third of loans originating in the financial system.

NBFC MFI market size: The Microfinance sector has grown over the years to reach a market size of ~INR 2 lakh crore with 6.4 crore unique live borrowers. The share of NBFC-MFIs in the overall microfinance sector has come down to a little over 30 per cent at INR 60 thousand crore or USD 8 billion.

Share in MSME lending: The share of non-bank lenders in MSME lending increased from 7.9% in Dec 2015 to 12.5% in Dec 2019

Share in asset financing: NBFCs finance more than 80% of equipment leasing and hire purchase activities in India

AUM growth rate: Between March 31, 2009 and March 31, 2019, the total assets of NBFCs grew at a compounded annual growth rate (CAGR) of 18.6%. Assets under management for NBFCs to be stagnant for 2021 as per domestic rating agency, India Ratings and Research. The rating agency has revised its outlook to negative from stable for the securitisation transactions backed by microfinance loans, unsecured business loans and construction equipment loans because of the uncertainty around slippages after moratorium.

Public funds: The public funds of NBFCs increased from US$ 278.23 billion in 2016 to US$ 470.74 billion in 2020 at a CAGR of 14.04%.

NBFC Public funds (in US$ billion)

Source: RBI, NHB, EY Analysis.

Exhibit 7: Share of loans to ‘New to Credit’ customers (FY19)

Source: TransUnion CIBIL, FICCI

Exhibit 9: Share in new loans originated-Region wise (FY19)

Source: TransUnion CIBIL, FICCI

Barriers to entry

NBFC license: The process of procuring the NBFC license is quite complicated. The process involves complicated documentation procedures and approval from the Reserve Bank of India.

NBFC Compliances: NBFC compliance varies from one type of NBFC to another. The team needs to have internal resources and personnel who can understand and navigate these compliances and complexities. Alternatively, a professional group of consultants can be hired for NBFC documentation, license, and Compliances.

Disparate tax treatment: There lies a great inequality in the tax structures for banks vs. NBFCs like Tax deduction at source, dual taxation on lease/hire purchase, etc.

Lack of defaulter database: NBFCs are susceptible to credit risk due to the lack of vital information and credit profiles of target customers. This makes it necessary for companies to have a strong grassroot level understanding of the market to effectively reduce their default risk. They can also partner with Fintech players as their offerings are faster, cheaper, and better in terms of lending, brokerage, payments, and credit scoring.

Types of NBFCs

a) in terms of the type of liabilities into Deposit and Non-Deposit accepting NBFCs,

b) non deposit taking NBFCs by their size into systemically important and other non-deposit holding companies (NBFC-NDSI and NBFC-ND) and

c) by the kind of activity they conduct.

Within this broad categorization the different types of NBFCs are as follows:

I. Asset Finance Company (AFC) : An AFC is a company which is a financial institution carrying on as its principal business the financing of physical assets supporting productive/economic activity, such as automobiles, tractors, lathe machines, generator sets, earth moving and material handling equipments, moving on own power and general purpose industrial machines.

II. Investment Company (IC) : IC means any company which is a financial institution carrying on as its principal business the acquisition of securities,

III. Loan Company (LC): LC means any company which is a financial institution carrying on as its principal business the providing of finance whether by making loans or advances or otherwise for any activity other than its own but does not include an Asset Finance Company.

IV. Infrastructure Finance Company (IFC): IFC is a non-banking finance company which a) deploys at least 75 per cent of its total assets in infrastructure loans, b) has a minimum Net Owned Funds of ₹ 300 crore, c) has a minimum credit rating of ‘a’ or equivalent and d) has a CRAR of 15%.

V. Systemically Important Core Investment Company (CIC-ND-SI): CIC-ND-SI is an NBFC carrying on the business of acquisition of shares and securities.

VI. Infrastructure Debt Fund: Non- Banking Financial Company (IDF-NBFC): IDF-NBFC is a company registered as NBFC to facilitate the flow of long term debt into infrastructure projects. IDF-NBFC raise resources through issue of Rupee or Dollar denominated bonds of minimum 5 year maturity. Only Infrastructure Finance Companies (IFC) can sponsor IDF-NBFCs.

VII. Non-Banking Financial Company — Micro Finance Institution (NBFC-MFI): NBFC-MFI is a non- deposit taking NBFC having not less than 85% of its assets in the nature of qualifying assets which satisfy the following criteria:

a. loan disbursed by an NBFC-MFI to a borrower with a

rural household annual income not exceeding ₹ 1,00,000 or

urban and semi-urban household income not exceeding ₹ 1,60,000;

b. loan amount does not exceed ₹ 50,000 in the first cycle and ₹ 1,00,000 in subsequent cycles;

c. total indebtedness of the borrower does not exceed ₹ 1,00,000;

d. tenure of the loan not to be less than 24 months for loan amount in excess of ₹ 15,000 with prepayment without penalty;

e. loan to be extended without collateral;

f. aggregate amount of loans, given for income generation, is not less than 50 per cent of the total loans given by the MFIs;

g. loan is repayable on weekly, fortnightly or monthly instalments at the choice of the borrower.

I. Non-Banking Financial Company — Factors (NBFC-Factors): NBFC-Factor is a non-deposit taking NBFC engaged in the principal business of factoring. The financial assets in the factoring business should constitute at least 50 percent of its total assets and its income derived from factoring business should not be less than 50 percent of its gross income.

II. Mortgage Guarantee Companies (MGC) — MGC are financial institutions for which at least 90% of the business turnover is mortgage guarantee business or at least 90% of the gross income is from mortgage guarantee business and net owned fund is ₹ 100 crore.

III.NBFC- Non-Operative Financial Holding Company (NOFHC) is financial institution through which promoter / promoter groups will be permitted to set up a new bank. It’s a wholly-owned Non- Operative Financial Holding Company (NOFHC) which will hold the bank as well as all other financial services companies regulated by RBI or other financial sector regulators, to the extent permissible under the applicable regulatory prescriptions.

Apart from the above types of NBFCs as categorized by RBI, peer-to-peer lending (P2P) which is one of the fastest growing segments has also been categorized as a NBFC by the RBI. P2P lending has seen strong growth by leveraging a tech-driven business model and the power of social networking.

Products and Services of NBFCs

● Construction equipment

● Commercial vehicles and cars

● Gold loans

● Microfinance

● Consumer durables and two-wheelers

● Loan against shares, etc.

Below are the major products offered by NBFCs in India:

● Funding for commercial vehicles

● Funding for infrastructure assets

● Retail financing

● Loan against shares

● Funding for plant and machinery

● Project finance

● Unsecured personal loans

● Trade finance

● Venture finance

● SME financing

○ Financing of specialized equipment

○ Operating leases of cars, etc.

Following are the different financial instruments or agreements that NBFCs execute:

● Loans

● Hire purchase

● Financial lease

● Operating Lease

Strategic Opportunity

The vision and objectives have a significant overlap with those of the NBFCs and both are working towards helping the marginalised population. Build capabilities and enter the NBFC space to offer product and service and establish presence across all the customer touch-points for the target population, from banking them, enabling cash deposits and withdrawals, lending and collections to selling value-added products like insurance customised to their requirements.

Catering to the underserved: NBFCs are primarily targeting them to meet their financing needs, otherwise unmet by the formal banking sector. Focus efforts on this population segment and specifically women to bring them under the banking umbrella and help them move towards a secure and better life through financial prosperity.

Wide geographical reach: NBFCs have established a widespread geographical reach by understanding the financial needs of this target segment and building processes tailored to them. Build a dense network of business correspondents that even in the remote areas reach this customer segment. Their relationship and trust with the target population can be leveraged to upsell the offerings of the NBFCs.

Specific skills, resources and channels: Build a relationship-based business based on trust with key stakeholders like village panchayats in your area of operations to promote the business as well as partnerships with trusted people in those regions who can act as influencers and be your agents. This is crucial to capturing information of the target customers from alternate, informal sources and building a customer profile.

Build a niche portfolio through its NBFC arm for better growth: Target customer portfolio through small ticket business and personal loans as well as look towards asset financing for the farming sector to create a lending portfolio. The business and agent relationships in those areas can help in collections and work towards preventing loans going into NPAs.

Low turnaround time for lending: Access to informal information about the target customers can help in drastically reducing the TAT for processing loans.

Creating opportunities for women: There is a need to create a vision of empowering women by providing them access to finance for setting up cottage, micro and small scale industries.

NBFCs are facing a no. of operational challenges around their liquidity, increasing credit risk and NPAs, lower collections and low customer awareness about the financial products, all of which are crucial to their health of operations.

Growth Aspects and Focus Areas

NBFCs in the micro finance and asset finance segment operate in a niche space.

NBFC Target Profile

1. Geographic Reach: NBFC with a deep presence in regions where the business has strong operational presence can be explored for acquisition to increase its product offerings.

2. Product/service segment: NBFCs or loan books that focus on micro-financing or asset financing like tractors for underserved populations need to be targetted. For micro-financing, SHGs formed and governed by women can be targeted to empower them and help them attain financial independence.

3. Digital Channels and Presence: If setting up own NBFC, while there will be some manual operational efforts like customer sourcing and due diligence, focus should be there on setting up digital operations. Eg. based on existing customer interaction, generating potential customer list, loan approval, underwriting, loan disbursement, collections or when the customer is due for their next instalment can all be managed digitally. Initially, agents will be using the digital application largely, but they can help educate the customers towards using digital channels to access their account details and perform basic functions. This will help reduce the cost of operations.

4. Regulatory compliance: If acquiring a NBFC, due diligence should be done around whether they have been properly complying with all the regulatory requirements or not

NBFC Market Entry Strategies

1. Start own NBFC: Apply for NBFC license with RBI and set up own operations by utilizing own funds for the first cohort. Leverage own BC network for identifying potential customers, underwriting loans for them and building a loan book.

2. Acquire loan book of an existing NBFC: Raise investor funds to acquire the loan book of an existing NBFC. Target a NBFC whose loan book is disbursed in regions where you have a strong network presence and leverage your ‘Business Correspondents’ network in collections and recoveries of the loans

3. Acquire a NBFC: Raise investor funds to acquire a NBFC. Here, the entire operations of the NBFC have to be acquired, which will make you responsible for maintaining the books and accounts for that acquired NBFC.

* Business Standard, Wednesday, September 7, 2022



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