Non Banking Financial Companies in India (NBFC): A perspective

Posted on December 28, 2008

Non Banking Financial Companies or NBFC in India are registered companies conducting
business activities similar to regular banks. Their banking operations include making loans and
advances available to consumers and businesses, acquisition of marketable securities, leasing of
hard assets like automobiles, hire-purchase and insurance business.
Though they are similar to banks, they differ in a couple of ways. NBFC’s cannot accept demand
deposits (deposits that can be withdrawn at immediate notice), they cannot issue checks to
customers and the deposits with them are not insured by the DICGC (the India equivalent of
FDIC in the US system). Either the RBI (Reserve Bank of India) or the SEBI (Securities and
Exchange Board of India) or both regulate NBFC’s.

Though the NBFC’s have been around for a long time, they have recently gained popularity
amongst institutional investors, since they facilitate access to credit for semi-rural and rural India
where the reach of traditional banks has traditionally been poor.

NBFC’s have also had a major impact in developing small business in rural India through local
presence and strong customer relationships. Usually the loan officers in such NBFC’s know the
end customer or have a strong ‘informal’ understanding of the credibility of the borrower and are
able to structure their loans appropriately.

With the next wave of growth in India expected to come from the semi-rural and rural sector, the
unique access of NBFC’s to these sector puts them in a great position to benefit from this
growth. As evidence of their attractiveness, Goldman Sachs bought a 20% stake in Sriram Credit
for 75 mUSD in Q1 2008. Credit Suisse is planning to take a majority stake in Bokdia Marketing
and Finance (as reported in May 2008). Foreign Institutional Investors (‘FII’) are also setting up
their own NBFC’s in India to offer corporate banking and private banking operations. As an
example, Societe Generale got approval for its NBFC launch in the country in October 2007. The
French financial services group plans to strengthen its brand in India though NBFC’s.

There are three categories of NBFC’s,

a. Asset Financing Companies (‘AFC’)

b. Loan Companies (‘LC’)
c. Investment Companies (‘IC’)
In our current post, we will focus on two NBFC sectors of Microfinance and Infrastructure
finance which fall under the category of AFC and LC. In a future post, we would focus on
consumer finance with specific focus on the automobile sector.

Microfinance Sector (very attractive)

There is a huge need for credit in the rural sector in India. Roughly 245 million people need 52
bUSD of microfinance credit. This includes small and marginal farmers, landless labourers,
micro entrepreneurs in the rural and semi-urban areas. NBFC’s constitute almost 66% of the
microfinance (MF) sector. The customer base covered by microfinance is expected to reach 49
million people by 2012 growing at a CAGR of 43% with an expected loan portfolio of 6 bUSD.
(Source: Recent report on microfinance by Intellecap, a research firm specializing in
microfinance).

The key growth drivers in the microfinance sector are:

a. Need for broader suite of products: Products such as investment products, insurance
products, retirement planning can be offered to the customer base

b. Regional diversification: The NBFC’s in this space are mostly concentrated in South
India. I expect this to grow in other regions.

c. Market consolidation and entry of FII: The smaller NBFC’s will get acquired and large
FII’s (such as Fullerton) will come in and build franchising models to accelerate the
quality and penetration of MF in rural areas.

On the flip side, there are some constraints in the microfinance sector such as lack of regulatory
rules which are still evolving, lack of standardization, ability to attract quality human resources
and an industry attitude that it is still a social enterprise versus for profit professional enterprises.

Lastly, in terms of recent investment activity, SKS microfinance (37.3 mUSD), Share Microfin
(27.5 mUSD) and Spandana (12 mUSD) were financed in the last year. Additional NBFC’s such
as Bandhan, Cashpor and Grameen Koota are looking actively for investments.

Infrastructure Finance Sector (very attractive)

During the economic boom of the 1990’s, the Govt. implemented many policies for
infrastructure development with focus on roads, telecommunications, ports, and power. Special
purpose vehicles (‘SPV’) were formed to facilitate the credit demands of various projects. A
majority of these were setup as NBFC’s. The Govt. also implemented public private partnerships
(‘PPP’).

As a perspective, during the period 1990-2006, 233 PPP projects were completed with total
investment of 69 bUSD. The PPP investments grew from 0.6 bUSD in 1991 to 17.1 bUSD by
2006 representing a CAGR of 25%.

During the period 2007-2017 the levels of investment is expected to further accelerate fueled by
the economic growth and the need to catchup on infrastructure to facilitate this growth. During
this period investment of roughly 1500 bUSD (Source: Govt. website, World Bank and E&Y
report) would be needed on power, roads and telecommunications.

The Govt. is setting up favorable policies to attract at least 50% of this investment from the
private sector. The private NBFC’s are expected to become a major investment vehicle to funnel
the private investment into the growing infrastructure sector in India.

SG Analytics an investment research firm based in India which i work for does sector research
work on emerging markets such as India and China.

French bank BNP Paribas has been one of the few banks, who has in the past few years picked up stakes, and went
in for joint ventures in a host of areas such as life insurance, asset management, home finance and brokerage. ET
speaks to Jacques Michel — CEO & country manager of BNP Paribas, India, on the bank’s plans for India. Mr Michel
says India is among the strategic countries for BNP Paribas globally and is looking to triple its revenues from India in
the next 3-4 years while keeping its eyes open for inorganic growth.

Q: RBI has said foreign banks should look at the wholly-owned subsidiary route. What are the plans of BNP
Paribas?

A: Personally, having worked in Hongkong and Singapore, I have already experienced this in China. China had
proposed to foreign banks operating as branches — as is the case in India — to incorporate locally. And de facto
today, most of the foreign banks there —active players, including BNP Paribas, have incorporated locally their
Chinese operations. By doing so, it became possible to handle business which we were not allowed to under the
branch status. So there was a business incentive for foreign banks to incorporate locally.

Q: So are you looking at incentives for the subsidiary route in India?

A: We are considering setting up a wholly-owned NBFC, which will complement our existing banking licence. This will
help us offer our clients a larger product offering and we will be able to use it for portfolio management activities, fixed
income and equity derivatives to sell structured products and corporate finance activities. We are studying this option
currently and hope to apply for a licence in the near future. So, under the current banking licences and with an NBFC,
we will have sufficient leeway to operate in an efficient and profitable manner in India. To incorporate our operations
is something we would consider only if such a status gives us further flexibility of operations.

Q: So which are the areas where BNP would look at an inorganic growth in India?

A: It will be in asset gathering, what we call Investment Solutions. BNP Paribas has been organised around three
main poles — retail banking, CIB and Investment Solutions. Investment Solutions are all the activities related to asset
gathering, which includes wealth management, asset management, insurance, securities services and retail
brokerage. Moreover, we can create efficiencies by cross-selling between these different entities, between the JVs
themselves and between the bank and the JVs. We are open to pursuing any opportunity which might match our
long-term strategy.

Q: How much has BNP invested in India? Are you looking at more investments?

A: In the last few years, we have invested more than half a billion euros. We have a 26% stake in our life insurance
JV with SBI. We have a partnership with Geojit for retail and wholesale brokerage, with Sundaram we have four JVs
— one in asset management, in home finance and two in securities services and fund administration. Securities
services are very important for BNP Paribas globally and we have set up a business process offshoring hub in
Chennai, which provides services to Asia. We also have a partnership with Srei in equipment leasing/finance and we
also have BNP Paribas Real Estate with local partners.

It is important to keep in mind that out of the 85 countries, where BNP Paribas has a presence, only very few
countries have been designated by our top management as being of strategic importance. And India is one of them.
As a strategic country, we have priority in terms of resources — both capital and human.

Q: Are you looking at more JVs in India?

A: It would be on a case by case basis. Broadly speaking, partnership has been at the heart of our growth strategy in
India. Knowing the complexity of India and its size, this strategy has been a combination of the best of the two worlds.

You have two entities in the asset management sector in India and you will have to take a final call by the end of the
month with whom you will go forward. I cannot comment on it at this stage because the stakeholders are in
discussions and it is also a regulatory matter. You will appreciate that we give the regulator priority in these matters.

Q: Would BNP Paribas re-look at plans of getting into the retail banking sector in India?

A: We have no plans at this stage and it is not a priority. As far as the Asia-Pacific is concerned, it is not a part of our
strategy to roll out retail banking. We are looking to develop our presence in activities related to asset gathering —
insurance, asset management, wealth management, securities services, retail brokerage and wholesale brokerage.
We have the ambition to create a platform in India, which will offer a large and comprehensive range of financial
products, except savings accounts and an ATM network.

In India, we see that local banks are agile and have developed very comprehensive geographical coverage. Some
foreign banks are also in this market segment and the market is highly competitive. For overseas players like us, to
start now would be a challenge to make this activity profitable.
Are rural consumers becoming more demanding and discerning now?

Absolutely. You can’t go and sell what you have. You will have to design what they want. You can’t say
this has sold well in Mumbai, so let me go and sell it in some village as well. Look at vehicle loans. One
may be able to provide a monthly instalment scheme in cities because cash flows are pretty steady. In
rural areas, if you want to finance a vehicle, you need to offer a scheme based on seasonal cash flows.
You can’t say to the villagers that you have only the monthly instalment scheme and so they better take it.
Things don’t work that way.

Similarly, if they can buy only a 1/2 kg pack or a 250 gm pack, you better package your product that way.
You can tell them that buying half a litre of shampoo is much cheaper than buying several 50 gm sachets.
But affordability and cash flows are more important for them. Whatever you design for the rural markets,
you will have to keep in mind the limitations, circumstances and capabilities of the rural consumers.

Has Mahindra Finance tweaked any of its products to suit the rural market?

Yes, our car loans, for instance. In Mumbai, we finance 85% of the cost of the car with monthly
instalments over a tenure of four years. In rural areas, you need to be prepared for two things. One, ask
the rural consumer how much he can afford to pay as a monthly instalment. Then, you convert that
instalment into a loan and tell him that he is eligible for, say, a Rs 2 lakh loan. So, he will decide whether
he can bring in the remaining amount (to purchase the car) or not.

Earlier, he used to go to a moneylender or a friend for the balance, but these days, thanks to the high
gold prices, he may prefer to liquidate the small amount of gold he has.

Or, suppose he has an old vehicle, you can buy it from him and lend him
   
the balance needed to buy a new vehicle. Such exchange schemes have
Agriculture
worked well. In cities, it is your salary slip that decides your loan eligibility. accounted for 80-
In villages, it depends on how much you can afford to pay in monthly 90% of the rural
instalments. economy. Now, it has
declined to 40-50%.
Are repayments on time? This is a radical
change.
You need to know upfront that the rural consumer may not be able to pay    
every instalment on time. Typically, if someone does not pay for three
months, a financing company repossesses its asset. However, if you do
that in rural areas, you will have a situation where every customer’s vehicle comes to you at least once.

In urban areas, the creditworthiness of customers is tested by the credit bureau. But in the case of rural
customers, if you depend on a credit bureau to assess their creditworthiness, then most will not pass
muster. Many would have defaulted at least once before. So, you will end up having nobody to lend to.
You need to have a physical presence to understand the customer’s capability, limitation and business
background. Once you understand their cash flow based on these parameters, you can decide whether to
lend or not.

Has a lot changed in the rural economy?

Let me give you an example. Nowadays, people are buying tractors and paying the entire amount in cash.
A couple of years back, this was not the case. Customers used to bring just about 10% of the total
amount—the rest had to be funded. This means rural customers have more money and want to use it for
productive purposes. Earlier, they used to put their surplus cash in fixed deposits or in post-office savings.
That seems to have changed. It’s a big change in the rural economy and I would like to see more of it.
Now, what can they do with an asset (like a tractor) in the non-use period? It can be used for haulage,
trailer applications or excavations. In that way, their cash flows increase substantially from a single asset.
Where do all these extra earnings go? They are invested in health and education. Today, families are
more willing to spend on both. People are willing to buy insurance policies as well.

But most insurance companies still maintain health insurance is a push product in the rural
market...

If you don’t have money and I come and push my product, you will still not buy it. But if you have the
money, you might get convinced. Rural India is still an opinion makers’ market. It’s about consultation.
That’s why microfinance is successful. Consultation happens informally and locally. If that can be driven
well and you choose to give your product to the right customer, then you can increase the size of the pool.
So, rural marketing is about choosing the right consumer and convincing him. If he is convinced and is
able to convince more people, the product will be in demand.

Even so, distribution remains a challenge due to poor infrastructure…

True. Rural infrastructure is yet to catch up and utilisation of technology is yet to gather steam. That is
why the cost of transactions is still high. You might be willing to open 200 branches but the customer
might still be about 100 km away. You need to service him, but the eventual cost of the product would be
really high. So, the challenge is to find ways to bring down transaction costs using technology.

When good roads are built, transportation becomes easier. The availability of electricity is important as it
facilitates communication. With improvement in education, more sophisticated communication methods
would be used. But in a broader sense, I think television has done the trick of communicating, which is
why there are demands for certain products.

Are schemes like the NREGS (National Rural Employment Guarantee Scheme) strengthening the
rural economy?

Just announcements won’t help. If the announcement is followed by ground-level implementation, people
become interested in these programmes and join them. We are seeing it now. Apart from the government,
even private players are entering this space. Look at microfinance.

There is so much written about it. Until they saw some real action from microfinance, people had no faith
in its potential. It was looked upon as a social responsibility programme and was thought to be all about
distributing some funds to the poor. But when it assumed a commercial character, it became a win-win
process. So, I think most of these programmes have a win-win potential in them.

How are you addressing the technical challenges that you face in rural areas?

The rural consumer earns, sells and repays in cash. So, the nature of the rural market tests your ability to
handle large sums of cash. In our case, we collect Rs 500 crore a month in instalments across the
country. About 90% of it comes in cash. It is a big challenge for a finance company such as ours to
reconcile our accounts.

We have 25-30 chartered accounting firms running concurrent audits for us throughout the year. We have
introduced handheld devices, which our field officers carry while meeting customers. These handhelds
have wireless online connectivity, enabling us to update our central server as and when a transaction is
made. That’s how transaction costs become cheaper and more secure.

How are things going to pan out for the rural economy over the next 12 months?
Rural India is undergoing a transformation. Cash flow is improving, and it is not coming just from
agriculture. Labour deployment and asset deployment are also generating cash flows. Asset deployment
means hiring out tractors or other assets. Such sources account for 30-40% of rural cash flows. Hence,
the impact of lower yields, poor monsoons or declining crop prices is cushioned a bit.

At one time, agriculture accounted for 80-90% of the rural economy. Now, it has declined to 40-50%. This
is a radical change. Another change we have witnessed over the last six months to one year is the way
gold prices have risen. Various sections of our population keep their savings in the form of gold. When the
price soars to Rs 16,000-17,000 levels from the earlier Rs 2,000-3,000 levels, people tend to liquidate
some and use it for more productive purposes. These things, together with help from the government in
the form of support prices and so on, have supported the rural economy well.

www.upvery.com/66393-indian-tractor-market-2011-edition-market-research-report.html

http://www.ifmr.ac.in/cmf/publications/wp/2008/23_radcliffe-indias_mfi_transparency_gap.pdf

n1.slideserve.com/PPTFiles/presentation_63857_67347.pps
http://www.consumercomplaints.in/?search=Magma%20Shrachi%20Finance%20Limited

NEW DELHI, FEB 25: 

Pitching for industrial houses wanting to set up banks, the Economic Survey has said that
they should be given banking licences to promote the goal of financial inclusion.

“As regards allowing industrial houses, business houses and NBFCs to promote banks, they
may be allowed full banking licence with a provision for avoiding conflict of interest issues,”
the 2010-11 Survey tabled in Parliament today by the Finance Minister, Mr Pranab
Mukherjee, said.

Providing access to banking facility to all citizens is one of the main objectives of the
inclusive development agenda. While providing banking access, it said, the issue of
regulatory robustness for the banking sector should not be compromised.

“Therefore, the issue of providing eligibility norms for new entities to operate as banks is of
paramount importance,” it said.

Following announcement made by the Finance Minister in the last Budget, the Reserve
Bank had brought out a discussion paper in August 2010 on giving out new banking licences
to business houses and non-banking finance companies, and regulations for the same to
foster greater competition.
The RBI also sought to know “whether industrial and business houses could be allowed to
promote banks.” Also, if NBFCs should be allowed to convert into or promote banks.

The central bank has received comments on its discussion paper from all the stakeholders
and is expected to come out with final guidelines in the coming months.

Various entities like Reliance Capital, IndiaBulls, Religare, IL&FS, IDFC, IFCI and Aditya
Birla Financial Services are reported to be mulling entering the banking space.

At present, India has 27 public sector banks, seven new private sector banks, 15 old private
sector banks, 31 foreign banks, 86 regional rural banks, 4 local area banks, 1,721 urban
cooperative banks, 31 state cooperative banks, and 371 district central co-operative banks.

Besides, the Survey said, micro-finance Institutions (MFIs) and non-banking finance
companies (NBFCs) should be considered giving licence for only basic banking functions. It
said it is essential that the basic banking functions are clearly and objectively defined.

The survey also suggested variable capital requirement for banks based on the operation.

Design of Questionnaires

http://www.egyankosh.ac.in/bitstream/123456789/35445/1/Unit-14.pdf