The Hard Truth of NBFC Ecosystem: The Recovery of Money Market and The Future of Digital Non-Banking Financial Companies

NBFC in wooden block letters on indian currency.

Banks are not the only institutions that facilitate the flow of monetary finances in the Indian economy. Non-Banking Financial Companies (NBFCs) play an important role in modern day lending and financing in India.

As of 9th September 2020, Non-bank financial companies (NBFC) are back in the markets raising funds at ultra-cheap rates as the banking system runs into a huge surplus, but banks are still reluctant to give loans.

In an indication of stabilising financing conditions, fundraising by Non-Banking Financial Companies (NBFCs) in the short-term money market has risen nearly 15 times over the last four months. NBFCs raised Rs 63,677 crore in August through the issuance of commercial papers (CPs), a dramatic increase from the Rs 4,275 crore that they raised in April.

In its economic review for August, the Finance Ministry said that financing conditions for NBFCs have stabilised, along with a reduction of short-term yields in line with measures taken by the RBI. With all this buzz around “NBFC” let us understand in the most simplified language, what is a non-banking finance company and what is its future like?

Let’s begin with understanding what are NBFCs?

nbfc
NBFC and Banks are different not only in terms of operations but also in rules and regulations.

Basically a NBFC is a company registered under the company’s act 1956. They are engaged in the business of loans and advances. They are also engaged in business of acquisition of shares, stock, bonds, hire purchase, insurance or even chit funds. They do not include any institution whose principle business is agriculture. Agricultural companies are not NBFCs.

 

What do NBFCs do then?

These financial institutions do not own a banking license. They are also not supervised by a national or international banking regulatory agencies. NBFC’s facilitate bank type financial services although they do not have a full banking license- investment, risk pooling, contractual savings and market brokering and also retirement planning and underwritings.

NBFC can also not have any industrial activities or sale or purchase or construction of immovable properties.

An overview of Indian Non-Banking Financial sectors:

India’s financial sector is huge. It comprises of commercial banks and NBFC’s. These non-banking companies are small but also very important for Indian economy. This is because 70% of the population in India lives in rural areas.

So, what are the various NBFCs?

NBFC’s can be investment banks, mortgage lenders, money markets funds, insurance companies and hedge funds. Private equity funds, P2P lenders.

RBI
RBI introduced regulatory framework to distinguish banks and NBFC’s.

In the year 1965, the RBI introduced a separate regulatory framework to distinguish banks and NBFC’s.

In 1991, Indian Economy witnessed liberalization, privatization and globalization.

In 1992 measures of the effective regulation of the industry was suggested which ranged from compulsory registration to prudential norms.

In 1997 the RBI amendment act made it compulsory for NBFCs to start operations during the great recession from 2007 to 2009. The credit demands were unmet by traditional banks and this led to proliferation and rapid growth of NBFC.

NBFC and its impact on Indian Economy:

They have grown significantly over the last decade with a total asset size of more than 370 billion dollars in India which means they provided up to 20% of all credit in India until march 2018. Not only that, NBFCs contributed to at least 225 of lending every year on an average.

Interestingly NBFCs are more profitable than the traditional banks because they have lower costs and cheaper loans in fact the amount of money that the NBFCs land in higher than the banking sector surprisingly isn’t.

nbfc in rural india
NBFCs promote inclusive growth by catering to customers in both urban and rural areas.

NBFC also contribute largely to Indian economy by lending to infrastructure projects which require large amount of funds. They earn profits only over a longer time frame. NBFCs promote inclusive growth by catering to customers in both urban and rural areas.

They finance projects of small scale companies and provide small ticket loans for affordable housing projects and provide small ticket loans for affordable housing projects. In the future NBFCs will continue to experience robust growth with minimal instances of delinquencies.

That is if the credit flow does not stop and the risk mitigation mechanism improve.

 

The NBFC crisis and its future:

Over the last years the financial market has been in a turmoil and with a very few large Finance companies like infrastructure Leasing and financial services the one Housing finance and a few companies of Reliance group are facing very severe problems of liquidity and solvency now how big is the crisis.

One can see a lot of knee-jerk reactions and a lot of very serious emergency policy prescriptions which assumes that we are facing a very severe crisis.

NBFC

Union finance now suggests that the problem is so severe that RBI should open a special window of funds that can be lent to NBFCs. In fact, it goes on to say that the RBI should take the first loss of let’s say 10% and also the bank should be asked to lend more to NBFCs.

It is also suggested that the RBI should look at a special purpose vehicle which can lend funds to NBFCs on short term paper and besides there is this external commercial borrowing route.

Today housing finance companies can raise money only when they are financing affordable housing projects and that it should be made available to even real-estate companies.

There isn’t a very major crisis. Not yet.

 The second thing we know is that this crisis is not ravaging the entire finance sector not all NBFCs are in trouble. In fact, this is a situation that we saw in the late 80s and 90s and in those periods dozens of leasing and finance companies many of them run by very small fly-by-night operators.

They went belly-up now over the years. The regulations of NBFC have changed a vastly improved the quality of corporate management which run these companies have become much better and better and that is why we have a situation.

 

In only three NBFCs that we are talking about in all three cases the outcome of over-ambitious management trying to boost capital loan book and their profits by hook or by crook. So it’s not really a crisis affecting the entire sector.

There was a time when finance companies were small and doing very similar type of business which is retail financing leasing and so on now there are large segments which have come up with retail financing, housing finance lending to real estate project finance and so on. So forth even though all of them claim to do everything.

Many finance companies are doing just fine and they’re totally unaffected, so do they need support?

Surely not in a very crucial sense.

Last years (2018-2019) all of these finance companies improved their profitability and their loan quality now only a few of them that lent indiscriminately to the real estate sector siphoned off money and played the market capital game are down in the dumps.

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These ILFS (Infrastructure leasing and Financial Services) which is a category by itself need to be liquidated systematically.

So the RBI is right, it’s not a shadow banking crisis but a problem limited to few bad players.

Now what the promoters of these well-run companies should be doing is push these bad actors out of the system while selectively picking on the better assets to strengthen their own businesses and this is how the capitalist system should run.

How can we take advantage of a “crisis”?

This is how the system will be cleaned up and strengthened not by asking banks to lend more money to big companies. That apart the real crisis is somewhere else it is in credit rating agencies and mutual funds remember that all of these companies had managed to issue triple A-rated paper which was picked up a mutual fund.

Mutual funds were getting huge amounts of money thanks to a very successful but misleading campaigns. When they got the money the quality of standards of the investment standards declined and they bought all kinds of bad paper and they even became lenders directly to these NBFC.

nbfc lending
The ‘abrupt’ credit lending is deemed to be the main problem for Financial sector crisis.

So it’s almost as if they are there like banks and they’re supposed to buy securities. securities that is a paper but they became lenders to the promoter’s private finance companies of promoters which is extremely a wrong thing to do.

Now this is not the first time this has happened before. Rating agencies have come up short and mutual funds landed in a big crisis in 2008. We have to find out how the mutual funds and credit rating agencies actually suffer a loss.

I don’t know how this can be done. BUT- There has to be an incentive for doing the right things and there has to be a penalty or a disincentive in their own structure the way they make their money and unless every financial sector and companies does that we are going to see this thing happen over and over again.

All hopes are on SEBI (Securities Exchange Board of India) , to do this kind of a change in regulation, at this time of the year.

 

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