On an NBFC's critical parameters

For competitiveness, there are two components. One is the cost of funds and the
other is the ability to manage transactions cost-effectively. Transaction cost
includes the associated risk.

In a financial intermediary business, I think efficient fund raising can only be done
by entities that have institutional backing, that is, the ability to source deposits
from public. Banks are an example. NBFCs cannot match them in fund-raising; in
fact, NBFCs will be borrowing from them. And to that extent lending becomes a
disadvantage.

Where we can be competitive is the efficient management of transactions. Any

company that is able to have an advantage in transactions will offset other
disadvantages and in the long-term be competitive.

On the way NBFCs have evolved over the last five years:

The major change is structural, triggered by the Reserve Bank of India. It came in
January 1998, when prudential norms were made mandatory. That in a way forced
the exit of some small players, and the numbers have come down.

Even among the RBI-registered companies, the numbers may not be very large.
The number of players have come down. That has in a way aided the niche players.
For instance, it has changed the attitude of the lenders because they are aware of
the quality of borrowers. They are willing to take an exposure to a NBFC and the
rates have also become competitive. There was a time when even a Commercial
Paper (CP) of a finance company could not be easily placed. Today, things have
changed and the NBFCs are able to use other instruments.

The other major change is that the volume of business we can do has really
expanded because of fewer people. It has helped us pick up good risk from a larger
population. Now with the whole market being there, companies are available to
pick up good risk. In the last three years, the risk addition has been much better
than the past.

The NBFCs will now remain focussed and not look at unrelated business. All this
will help in removing some of the negative perceptions that people have had about
the NBFCs over the last few years. Any player in the finance business should
continue to look at unfolding opportunities. Entering insurance and other areas are
natural phenomena, they will help in broadbasing income stream.
On competition with banks:

The difference between a bank and an NBFC has narrowed. Other than deposit
taking activity, the assets are largely similar. The NBFCs have an advantage in
management of risks and reach, I would say. Apart from this there is always the
adaptability to change, where the NBFCs are fast. Newer banks are also quite like
that.

In the long-term, the gap between banks and NBFCs will narrow. In which case a
different breed of NBFCs will emerge. For instance, a very focussed entity catering
to a small area.

For a company to grow there must be avenues; the range of products it can offer
must keep increasing. Growth is possible only by giving varied products.

On the importance of size:

The question for the NBFCs, in general, should be how they can raise funds for
growth. If I had to choose between balance-sheet size and reach, I would choose
reach because that gives NBFC the ability to take good risks rather than being
focussed in one place. Reach may help you take good risks, but future growth will
be determined by how adequately and viably we can raise funds. That will be true
for banks also.

On ALF's strategy:

ALF has been predominantly in commercial vehicle financing. So far commercial

financing has been the domain of private sector finance companies. With new
players approaching this segment aggressively, retaining our marketshare in the
long-term will have to be done by matching the products of the competition. As a
consequence, the margins can be under constant pressure.

The other segment we are concentrating on is passenger cars. Here, banks are able
to position themselves aggressively in areas where they can reach faster. Metros
are almost out of reach for NBFCs.

The other segment we have is multi-utility vehicles (MUVs). It is more or less on

the pattern of commercial vehicles vis-a-vis risk. There we certainly have
considerable scope. The other segment is construction equipment...will take time
for others to get in. Monitoring these risks will have to be localised. It calls for a
lot more understanding of customers' cash flows.
Let us categorise the products into two. Cars will be personal products.
Commercial vehicles, MUVs and construction equipment, I will call infrastructure
products. The latter account for 80 per cent and the former 20 per cent of the
revenue. So, our strategy is to widen this and ensure that transportation and
infrastructural risk are brought down to two-thirds. And have one-third risk in the
personal side.

In the personal side, we are concentrating on expenditure that goes into a

household. In three years time... with this we will be able to retain and improve
market share in infrastructural section and also give an opportunity for growth in
the coming years. This is the strategy on our existing business.

We are also at an advanced stage of developing a loan portal by which we will

have the capability to distribute loan products of other intermediaries. The main
thing we are looking at is the management of the loan -- the back-office work of
processing and collection. We will also throw open our branches to monitor for
third parties. In the long-term this will enhance shareholder value.

On the impact of the strategy on ALF's risk:

Contrary to public perception, personal loans have a lower risk attachment.

Contrary to perception, this is one area where risk is low and returns are high. If
you look at the risk, I would say personal product risk evaluation is more
streamlined vis-a-vis commercial vehicles. Cash flow assessment is more accurate
in personal products. To make matters better, we will be connected. Customers
going to the dealer can obtain the vehicle without running around.

We are also roping in local strength. We are likely to expand our branches. We
intend having a service provider who will manage on our behalf. All this will be
linked. A franchise system, their job is to monitor, but no risk would be taken by
them.

On the pros and cons of being linked to manufacturer of CVs:

The advantages are that the goodwill of the manufacturer automatically flows to
the company. The fact that we use the same name has brought in a lot more
acceptability. Proving our credibility was not a problem.

The other advantage is the synergy that exists and the fact that we do not finance
competitor's vehicles make ALF the first choice of referral for dealers. They have
an assurance that a proposal referred here will not be converted into a competitor's
vehicle. A perfect synergy of business. That helps us in cornering a larger share of
Ashok Leyland vehicles.

Disadvantage is that because of the focus the entire market is not available. We are
restricted to just Ashok Leyland's share of the market. Given the restriction NBFCs
in general have on capital adequacy ratios, the money available for deployment is
going to be limited. It is for the company to see how much is to be distributed in
what segment. I may not feel comfortable disbursing everything in commercial
vehicles even if the money is available. That way our being a manufacturer
promoted company will not impair the overall growth.

On the recent slowdown in the commercial vehicle segment:

Our financial year begins now. Compared to last July, our disbursement has
doubled. Normally, when there is a slowdown, the not-so-serious players drop out.
We always found that during a slowdown our marketshare improves. One reason
will be that, when a slowdown takes place fringe players vacate. In a slowdown,
the commercial-vehicles-focussed companies fare better. I feel the slowdown is
temporary. It should change with the kind of growth in the economy that is
predicted. It should change September onwards.
Relationship between banks and NBFCs set to change

Based on the recommendations of the Internal Group and taking into consideration the feedback received
thereon, RBI has decided on 3rd Nov 2006, to put in place a revised framework to address the issues
pertaining to the relationship between banks and NBFCs. The revised framework will not be applicable to
the Residuary Non Banking Companies (RNBCs), which are governed by a separate set of regulations.

Bank Exposures to NBFCs

The exposure (both lending and investment, including off balance sheet exposures) of a bank to a single
NBFC should not exceed 5% of the bank’s net worth as per its last published balance sheet. Further, the
aggregate exposure of a bank to all NBFCs should not exceed 40% of the bank’s net worth, as computed
above.

Regulatory Framework for NBFCs Forming Part of a Banking Group

Henceforth, initially, wholly owned and majority owned NBFCs promoted by the parent / group of a foreign
bank having presence in India, would be treated as part of that foreign bank’s operations in India and
brought under the ambit of consolidated supervision. Consequently, the concerned foreign banks should
submit the consolidated prudential returns (CPR) prescribed by the above guidelines to the Department of
Banking Supervision and also comply with the prudential regulations / norms prescribed therein to the
consolidated operations of that bank in India.

For example Citibank will now be required to include financials of its NBFC arm, Citifinancials, in the
consolidated prudential returns.

NBFCs which do not belong to any banking group are currently permitted to offer discretionary portfolio
management as a product, as permitted by their respective regulators. Henceforth, bank sponsored
NBFCs will also be allowed to offer discretionary PMS to their clients, on a case to case basis.

Ownership and Governance

Banks in India, including foreign banks operating in India, shall not hold more than 10 % of the paid up
equity capital of an NBFC – D. This restriction would, however, not apply to investment in housing finance
companies.

Banks which at present exceed the above limits should approach the Reserve Bank, within a period of
two months from the date of this circular, supported by a plan for complying with the proposed regulatory
requirement within a specified time frame.

For example now DBS Bank will be required to reduce its stake in Cholamandalam DBS Finance. DBS
can approach the RBI within two months with a concrete plan to bring down its stake in the south-based
NBFC within a specified timeframe.