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
NBFCs have served the non-banking customers by pioneering into retail asset-backed lending as well as lending against securities and microfinance. NBFCs aspire to emerge as a one-stop shop for all financial services.
● Catering to the underserved: They have emerged as the primary financier to a vast section of the population including small and medium scale enterprises as well as the economically unserved and underserved individuals.
● Wide geographical reach: They have extensive geographical reach, understanding of varied financial needs of people and very low turnaround time. The ground-level presence and high-touch based collection mechanism is the key differentiator for NBFCs.
● Specific skills, resources and channels: Over the years, non-bank lenders have developed/acquired skill-based arbitrage in comparison with banks due to continuous innovation in their business model and processes that rely on surrogate non-financial information, use of third-party sales channels, and collection processes.
● Niche NBFCs fare better: Non-bank lenders focusing on niche segments are comparatively in a better place to capture growth and earn higher spreads. These segments include vehicle financing, small-ticket business loans, consumer durable loans, small ticket personal loans, structured finance to stressed corporates, special situations funding and credit to smaller developers
● Low turnaround time for lending: Turnaround time for loan processing is 18 days for NBFCs which is much lower as compared to 30 days for banks.
● Creating opportunities: Non-bank lenders play an important role in the economy by financing micro and small-scale industries (informal sector) and provide employment and entrepreneurial opportunities at a ground level.
Problem areas and challenges
● Lack of capital flow: Lapses in corporate governance of a few non-bank lenders have impacted the sector including capital flows which has not only left a dent on the reputation of the sector but has also adversely impacted its liquidity and profitability. There has been a sharp erosion of investors’ confidence, leading to drying up of capital flow towards a large section of this sector.
● Higher perceived credit risk: Banks and other lenders too have taken a cautious stance towards non-bank lenders owing to their higher perceived credit risk. This has intensified the liquidity crisis in recent times, particularly for the small and medium sized non-bank lenders that lack institutional support either from the government or large corporate houses.
● Increasing NPAs: Gross non-performing assets (GNPAs) for NBFCs increased to ~6.8% during FY21 as ~30%-75% of their loan assets were under repayment moratorium with collection efficiency reduced by over 30%.
● Poor regulatory frameworks: Deficiency in prevailing regulatory framework in terms of limited size-based differentiation in regulations among non-bank lenders and a long tail of non-bank lenders curtail bandwidth for oversight of large non-bank lenders. The regulatory framework for NBFCs needs to be reoriented to keep pace with changing realities in the financial sector.
● High cost of compliance: The levels and cost of compliance are increasing as a response to specific incidents being witnessed by the sector.
● High cost of funds: Biggest challenge faced by non-bank lenders is liquidity, and money does not come at a reasonable cost. Banks are flushed with liquidity, but they are not lending to non-bank lenders, especially smaller ones due to risk aversion. There is a need to reduce over reliance on banks for financing.
● Disruption in growth: Growth challenges include difficulty in rolling over existing debt and raising new debt due to liquidity squeeze. This is more pronounced for non-bank lenders who are directly competing with banks and lack pricing power (high ticket and long tenure loans).
● Competition from retail banks: As bond yields and market borrowing rates rose sharply, pricing power swung in favour of banks. Increased focus of banks towards retail lending led by surplus liquidity has helped them to fill the space vacated by the non-bank lenders and recouped their lost market share.
● Poor collection efficiencies: Reliance on cash makes the sector vulnerable to natural calamities and COVID-19 like situations where customers are impacted by lower incomes and outreach becomes difficult. This, coupled with loan moratorium extended by MFIs, resulted in collection efficiencies to drop below 10% in April and May 2021 (vis-à-vis 98% under normal circumstances). However, the collection efficiency of non-banking finance companies and housing finance companies recouped to the healthy range of 97–101 per cent in April and May 2022.*
● Higher risk of delinquency: Non-bank lenders’ exposure to MSME segment has a high gross NPA between 8.5% to 20% over the last five years. This higher NPA rate is on account of MSMEs being constrained for liquidity due to their limited bargaining power and delayed payments from clients.
● High touch underwriting process: Smaller MSMEs are largely informal with limited business documentation and collateral. This requires an understanding of the micro-market and a high touch approach to underwriting which increases cost of servicing thereby creating barriers.
● Due diligence: Since these customers do not have any credit history, it becomes difficult to verify their financial credentials. Therefore, NBFCs have to deploy additional resources for on-ground visits, psychoanalytic tests, reference checks and so on. All this adds to the operational cost and makes it tough to service this segment.
● Customer education: ‘New to credit’ customers may not naturally look to engage with any NBFC to attain loan for their personal or business requirements. Hence, to onboard such potential customers, NBFCs have to spend additional resources in financial literacy and awareness.
Effect of COVID-19 pandemic
Microfinance was adversely impacted during the first wave of the pandemic.
● Funding squeeze: Smaller NBFCs and Microfinance Institutions (MFIs), who were contributing significantly to the last mile credit delivery, got impacted as their funding sources got further squeezed.
● Weaknesses and fragilities uncovered: As financial markets started differentiating between strong/well managed NBFCs and those having perceptible weaknesses, market discipline started to play out . As a result, entities with asset-liability mismatches or asset quality concerns faced constraints on market access, reflective of inherent fragilities in NBFC operations.
● Drop in business metrics: Many non-bank lenders faced a 20%-30% drop in disbursements volume in Q4FY20 over the previous year. In the next quarter, i.e., Q1FY21, loan disbursements further dropped by 80%-90%. Resumption of demand for credit facilitated higher disbursements by Q4FY21.
● Fall in securitization volumes: Non-bank lenders relied on securitization as a tool for raising funds and address ALM mismatch with its volume reaching as high as 30% of the assets for a few non-bank lenders. However, the uncertainty from the outbreak of the COVID-19 pandemic, long moratorium period and resultant economic slowdown impacted the loan volumes.
● Increased focus on collections: NBFCs have increased their focus on collections and have tightened underwriting standards, and so portfolio growth would take a back seat.
● Regulatory measures: The Government has been swift enough to undertake several measures to ease the situation prevailing in the sector by way of providing liquidity support to NBFCs, HFCs, as well as MFIs and introducing partial credit guarantee schemes, etc.
● Required shift in operating models: Recent adverse industry events and the outbreak of COVID-19 pandemic requires the sector to be more resilient and focus on realigning the business model through effective use of technology:
○ Digital first approach towards products — Acquiring new customers and cross-selling to existing customers through an assisted-digital model for unsecured and asset backed loans in a phased manner.
○ Analytics driven decision making to prioritize customer use cases — Using analytics across the value chain for data driven customer insights, customer acquisition, channel management, portfolio and performance management, productivity and service process and operations and support.
○ Leverage partner driven ecosystem and collaborations to drive growth — API-based business models in partnership with FinTechs to offer value added services.
○ Technology enablement using innovative platforms — Optimizing the value chain through technology which encompasses real-time, event-driven and component based characteristics.
○ Maintain tight risk management controls- Building robust technology infrastructure in risk management and making it part of future roadmap to enable alignment, convergence and efficiencies.
○ Attract, retain and grow the best talent — Creation of talent hubs, building employer brand and restructuring of the workforce.
Financial Performance of NBFCs
While NBFCs fare better than commercial banks on Net Interest Margin (NiM) and Returns on Asset (RoA), they still have a slightly higher Gross Non-performing Assets (GNPA) compared to bank. This is primarily due to a higher credit risk associated with non-bank lending.
● 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
Exhibit 6: Trend in Asset quality of banks and non-bank lenders
Profitability of NBFC Sector (Deposit Taking and NDSI)
Industry Size and Growth
● Number of NBFCs: There are over 9,500 NBFCs registered with the RBI. You can access the entire list here.
● 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)
Exhibit 7: Share of loans to ‘New to Credit’ customers (FY19)
Exhibit 9: Share in new loans originated-Region wise (FY19)
Barriers to entry
● Funding and refinancing: NBFCs are dependent on banks or the capital markets for raising resources. This is quite unfavorable to new entrants unless they have a reliable source of funds and options for refinancing.
● 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
NBFCs are categorized as follows by the RBI:
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
NBFCs offer a wide range of services, from loans and advances, credit facilities, savings and investment plans, money transfer service and insurance. NBFCs typically engage in the following types of funding:
● Construction equipment
● Commercial vehicles and cars
● Gold loans
● 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:
● Hire purchase
● Financial lease
● Operating Lease
To offset the impact of pandemic on the business, alternate growth strategies and initiatives need to be explored around new product or service offerings and partnerships or acquisitions to negate the impact of the pandemic. NBFCs which have been crucial in the past for providing financial services to the poor and underserved population are facing a crisis due to the liquidity crunch which has been amplified by the pandemic.
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
Having a strong presence and deep engagement with the customers on the upstream services like banking can provide an opportunity of upselling products and services on the downstream like lending, collections, investment and saving instruments and insurances.
NBFCs in the micro finance and asset finance segment operate in a niche space.
NBFC Target Profile
A business that is strong in building and running the operations heavy business through an established field force and penetrating the market through them should target towards acquiring a NBFC with the following characteristics:
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
One can enter the NBFC market in one of the three ways:
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