NBFCs – India’s growth counterpart

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A short analysis by Pankaj Singhania, Founder Lakewater Advisors

Indian economy is undoubtedly going through turmoil with unemployment
at its peak (at 6.1%), high consumer price index (149.10 points) and
low performance in almost all the sectors, with banking being the
highlight.

However, while the Non-Performing Assets (NPAs) in banking are
constantly growing in numbers, we planned to scan Non-Banking Financial
Companies (NBFCs)in the same segment and looking at the performance, are
bullish about their growth. To understand NBFCs better, let’s
understand their classification and products covered first.

Classification of NBFCs

NBFCs in India are classified under three categories (as per RBI):

Products covered under NBFCs

NBFC sector in India has gone through considerable reforms over the
past few years and has been synonyms to regular banking in the current
scenario. Nearly 10,000 NBFCs registered themselves with RBI till 27
March, 2019.With its steady growth, it is now accepted as a vital
constituent in micro-economic perspective. Reasons being:

  • NBFCs have been a pioneer in providing credit facility to undeserved
    Micro Small and Medium Enterprises (MSME) and unbanked sector, which
    has helped in the overall economy of India.
  • NBFCs are an accelerator to RBI to expand the target market to semi urban and rural area.

Why are we bullish on NBFCs?

FY19 began with high expectation as it seemed the economy is settled
from teething troubles of Demonization and Goods and Service Tax (GST).
However, the economy didn’t live up to the expectations due to rising
NPAs and liquidity crises.  Among all these crises, inflation gave a
relief as Consumer Price Index (CPI) was recorded below 4%.

Nonetheless, we believe while the banking sectors hold its hand
tight, it was NBFCs who kept the ball rolling. ~17% of the total credit
in India is provided by NBFCs and it has registered a growth rate of 20%
in FY18, which undoubtedly slowed down after default of IL&FS.
However, the aggregate capital adequacy ratio stood strong at 19.3% as
on March’19.

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Looking at the road map, the following reasons can be attributed for NBFC’s consistent growth:

A: Retail Finance

In the retail finance space, NBFCs have swiftly
developed a stand. ~80% of equipment leasing and hire purchasing
activities in India is financed by NBFCs.

In spite of liquidity crises, NBFCs had a share of 30% in outstanding retail loans in FY19.

Share of outstanding retail loans by value in FY19(%)

B. Public Deposits
Public deposits of NBFCs grew at a CAGR of ~36% for the period FY09-18. This shows strong consumer confidence in the segment unlike the shaking hands in banking industry.

C. Micro Finance Institutions (MFIs)
NBFC have made an instrumental reach in rural credit institution in the form of NBFC-MFIs. Due to the regulatory guidelines on NBFC-MFIs; MFIs resulted exceptional growth between 2013-2019 as perJoint Liability Group(JLG)model. Below is a chart showing the number of clients outreached and gross loan portfolio generated.

D. Micro, Small and Medium Enterprises (MSMEs) –
Since NBFCs has a profound knowledge about micro markets, it has been able to concentrate on the lower segment via product customization. In order to expand the reach, MSME focused NBFCs, have made their model based on segment, product and geography. NBFCs share in MSME Finance is increasing, while that of public sector banks is going down.

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E. Scheduled Commercial Banks (SCBs)
NBFCs surpassed SCBs on account of growth in advances, asset quality and profitability. While SCBs are giving nil or negative return on assets and equity, NBFCs had given ROE (Return on Equity) of 7.5% as on 31st March, 2018. This momentum will be accounted in Financial Sector’s growth in near future.

F. Increasing Reach and Network
NBFC is increasing its network by reaching out to Tier-2, Tier-3 and
Tier-4 markets. Due to evolvement of digitalization, NBFCs can now
provide seamless 24*7 customer satisfaction experience. Also,
collaborating with alternate lender on digital platform has increased
their targeted customer base.

G. Government Support
The Finance Minister has announced in Union Budget to provide a partial
credit guarantee facility to PSUs worth INR 1 lakh crore for the
procurement of high-rated pooled assets of fiscally stable NBFCs. This
measurement should benefit NBFC sector and pump up investor’s belief.
In addition to the above, RBI has ruled out a new set of guidelines for
NBFC, in respect to capital requirement and provisioning norms. It’s
anticipated these new guidelines should support the growth of NBFCs in
the long run.

Conditions Apply*

While all the above-mentioned points lead forward to a strong
foothold for NBFCs, they undoubtedly come with few conditions. On top
being:

1. New Age FinTech Companies

Technology had helped NBFC to create credit assessment models and
optimize the same. However, due to the new age Fin-Tech companies, NBFC
has been facing stiff competition from them in terms of the upgraded
technology and low cost operating models. In the near future, NBFC
should develop new channels by being aggregators to Fin-Techs or they
may stay behind in the race.

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2. Stay alarmed on NPAs

Non-Performing Assets have created distress in Indian Banking sector.
Since, banking sector has constrained their hands in lending
activities, NBFCs has a new opportunity in credit sector to indulge in.
However, they need to trade on a cautionary note and should not
compromise growth with safety.

Conclusion

The budget of FY19 aspire economy to achieve US$ 5 Trillion in 2024.
However, this seems challenging as NBFC crises have been highlighted in
the Economic Survey 2018-19. The default of IL&FS in September 2018
played a major role for this survey, as this made investors watchful
regarding their funding activities. NBFC was just a 4 lettered word in
the money market after this crumble.

Nonetheless, importance of NBFC has been recognized by Prime Minister
and to promote the same certain policy announcements has been carried
out. One such step is coverage of NBFCs under the Credit Guarantee Fund
Trust for Micro and Small Enterprises Scheme. Apart from that, domestic
financial institutions like NABARD and SIDBI are also refinancing NBFCs.
RBI too is streamlining the system to boost NBFCs and providing more
liquidity.
All in all, these measurers along with the growth numbers, project that
NBFC will be invigorated and reinvented.Lakewater is with them.

Annexure:

Performance of selected NBFC / Consumer Finance companies for the last 5 years.

Sources:

https://in.finance.yahoo.com/
https://www.epw.in/journal/2019/50/commentary/rising-unemployment-india.html
https://www.rbi.org.in/Scripts/FAQView.aspx?Id=92
https://www.pwc.in/assets/pdfs/consulting/financial-services/fit-for-future-nbfcs.pdf
https://www.entrepreneur.com/article/344069
https://www.business-standard.com/article/finance/nbfcs-continue-to-hold-major-share-in-retail-loans-despite-liquidity-crisis-119081901465_1.html
https://pib.gov.in/newsite/PrintRelease.aspx?relid=192618
https://www.ibef.org/industry/financial-services-presentation
https://www.caluniv.ac.in/dj/BS-Journal/vol-38/Growth-Trend.pdf
https://m.rbi.org.in/Scripts/FsReports.aspx

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Lakewater Advisors
The founder, Pankaj Singhania, is a Chartered Accountant and Cost Accountant. He has a distinctive knack for analyzing company fundamentals in tandem with management credentials.
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