By Sourav More
IFMR GSB – MBA Batch of 2023
“An essential feature of the evolution of the financial system has been the emergence of non-banking financial institutions,” read an RBI press release on 2 January 2012. Time and again, they have emerged as an epicentre to support the often credit-starved MSMEs and Rural India. The NBFCs landscape in India is a story in itself, as it has been a rollercoaster ride for them right from their humble beginning in the 1960s to finding innovative ways to drive the growth of MSMEs; and then the sudden shakeup due to the default in debt repayment by IL&FS group in the latter half of 2018, which ultimately resulted to a liquidity crunch and had negatively impacted their stock prices.
Growth Drives
- NBFCs mainly targeted the customers who are from the unorganised and under-served segments, customised their products as per their preference, and thus, NBFCs created a niche for themselves.
- NBFCs have always come up with newer and better technology for their customers, with 24/7 service and reaching the Tier-2, Tire-3, and Tier-3 markets. This helped them have a wider reach.
- NBFCs have been trying to set up co-lending arrangements with digital platforms and commercial banks, like Punjab National Housing Corporation – a part of Punjab National Bank.
- NBFCs are investing in data analytics and artificial intelligence to enhance their business operations and also commensurating technological advances.
- NBFCs are focusing on lending to the subprime customer segments through proactive, robust and agile risk management modules, in comparison to commercial banks.
NUMBER OF NBFCs IN INDIA AND ITS DECLINE OVER THE YEARS
Roadblocks to these growth prospects
- NBFCs have been trying to offer customers the kind of products that they want through constant customisation and innovation, and this has led to misalignment in product offerings with customers and a rise in the cost of investment and operations.
- The asset-liability mismatch, which became the cause of concern for the Liquidity Crisis of 2018, was mainly because NBFCs borrow funds at a lower rate for a shorter time period and lend the same at a higher rate for a longer time period, and after four to five years the interest rate usually increases and ultimately it leads to a loss for the company. Due to this, their liabilities were maturing faster for payment compared to the loans advanced.
- NBFC payroll had a downward spiralling effect on their quality of sourcing due to the absence of direct sales agents. Effective underwriting was required to form personal relationships with prospects.
The liquidity crisis of 2018: Case of DHFL
Dewan Housing Finance Limited (DHFL) provides home loan services and was one of the biggest housing finance companies in India. Unexpectedly, their share prices fell down by more than 60% after 21 September 2018 which created panic in the market. There was a rumour that DHFL may have defaulted in one of its debt payments, and people said that DSP mutual fund sold short term DHFL papers at 11 percent yield which was at a discount of 18 percent to its actual yield. Investors were worried why an AAA-rated company sold its short-term papers at such a discount.
Upon further discussion, it was identified that the fund house had IL&FS debt and IL&FS was roiled by a lot of defaults in commercial papers, which led to a shortage of INR 1000 billion in the system. Exposure to IL&FS formed the base of all the rumours and it spoiled DHFL’s valuation, and the same thing happened for other NBFCs as well.
Steps taken by the Reserve Bank of India
- On 2 November 2018, RBI announced Partial Credit Enhancement (PEC) to bonds, the period of occupancy of which should not be less than three years. These were issued by systemically important non-deposit takings of NBFCs amid the liquidity crisis.
- To reduce the stress of NBFCs, RBI relaxed its rules to sell or securitise the loan books. Therefore, NBFCs can securitise loans of more than five-year maturity after holding those for six months.
- Harmonisation of different categories of NBFCs into fewer ones was done for greater operational flexibility. AFC, LCs and ICs were merged into a new category called NBFC-Investment and Credit Company (NBFC-ICC).