NBFCs – On the growth trajectory

NBFCs – On the growth trajectory[1]

Executive Summary

On December 24, 2019 Reserve Bank of India (RBI) issued the “Report on Trend and Progress of Banking in India 2018-19”, the report presents the performance and salient policy measures relating to the banking sector including Non-banking financial companies (NBFC) during 2018-19 and 2019-2020 so far (till September 30, 2019). As per the report, although the NBFC sector grew in size from ? 26.2 lakh Crores in 2017-18 to ? 30.9 lakh Crores in 2018-19, the pace of expansion was lower than in 2017-18 mainly due to rating downgrades and liquidity stress in a few large NBFCs in the aftermath of the IL&FS event. This slowdown was witnessed mainly in the NBFCs- ND-SI category, whereas, NBFCs-D broadly maintained their pace of growth. However, in 2019-20 (up to September) growth in balance-sheet size of NBFCs-ND-SI as well as NBFCs-D moderated due to a sharp deceleration in credit growth.

Also, as a forward looking approach, Government of India (GoI) along with RBI (Reserve Bank of India),  in order to revive the NBFC Crisis, has been taking numerous steps such as providing partial credit guarantees to public sector banks to buy high-rated pooled assets of financially sound NBFCs, including housing finance companies (HFCs) and credit through National Housing Bank (NHB). Further, RBI has strengthen the asset liability management framework for NBFCs which requires them to have a strong liquidity risk management approach with granular bucketing of inflows and outflows to monitor the fund flows minutely. Furthermore, the Finance Bill 2019 through amendments in the RBI Act, 1934 conferred powers on the Reserve Bank to bolster governance of NBFCs. In order to maintain the financial stability in the financial sector, RBI is constantly engaged with NBFCs are make all possible steps towards the betterment of credit growth without compromising the governance issues.

NBFCs – a brief analysis

A) Role of NBFCs in Financial System and contribution to growth

NBFCs are classified on the basis of (a) their liability structures, (b) the type of activity they undertake and (c) their systemic importance. Under their liability structure, NBFCs are further subdivided into NBFCs-D which are authorised to accept and hold public deposits and non-deposit taking NBFCs (NBFCs-ND) which do not accept public deposits but raise

Debt from market and banks.

NBFCs play a supportive role in the entire financial system by providing credit to unbanked, un-served mass of the country. NBFCs are supplementing the banking system by ensuring access to credit to the population in the country who do not have access to mainstream financial products and services.

NBFCs sector has been under strict regulatory measures in the recent times. At the end of September 2019, the number of NBFCs registered with the RBI declined to 9642 from 9856 at the end of March 2019. NBFCs are required to have a minimum net owned fund (NOF) of ? 2 Crores.

In a proactive measure to ensure strict compliance with the regulatory guidelines, the RBI has cancelled the Certificates of Registration (CoR) of NBFCs not meeting this criterion. The number of cancellations of CoRs of NBFCs has substantially exceeded new registrations in recent years. During FY 2018-19, Certificates of Registration (CoR) of 1851 NBFCs were cancelled against the total CoR allowed which was 166.

The consolidated balance sheet of NBFCs expanded marginally in 2018-19 and in 2019-2020 (up to September), mainly because of down-grading of ratings and liquidity crisis. The slowdown was mainly witnessed in the NBFCs-ND-SI (non-deposit taking systemically important NBFCs) category, whereas NBFCs-D (deposit-taking NBFCs), maintained their expansion but marginally.

As per the analysis, there has been decline in the number of NBFCs as also slowdown in credit expansion, mainly due to stress scenarios and availability of credit from banks.

B)  Sectoral Credit of NBFCs

Credit extended by NBFCs continued to grow in 2018-19. Industry is the largest recipient of credit provided by the NBFC sector, followed by retail loans and services. Credit to industry and services were subdued in relation to the previous year. However, growth in retail loans continued its momentum. Over 40 per cent of the retail portfolios of NBFCs are vehicle and auto loans.

C)  Asset Quality in NBFC sector

In 2018-19, NBFCs registered a deterioration of asset quality. While the gross non-performing assets (GNPAs) ratio increased, net non-performing assets (NNPAs) ratio edged up marginally, reflecting sufficient provisioning. In 2019-2020 (up to September), asset quality of the sector showed deterioration with a slight increase in GNPA ratio. In terms of asset composition, the proportion of standard assets declined, part of it being downgraded to the substandard category in 2018-19. In 2019-20 (up to September), while the proportion of sub-standard assets remained unchanged, an increase in proportion of doubtful assets was observed.

D) Profitability

The profitability in NBFC sector can be gauged by key indicators such as Net Interest Margin (NIM), Return on Asset (ROA) and Return on Equity (ROE). In case of NBFCs-ND-SI, the overall profitability decreased in 2018-19. However, they posted an improvement in profitability indicators in the current financial year till September 2019, on the back of decline in other expenses.

In case of NBFCs-D, there has been overall improvement if NIM and profitability has improved.

E)   Capital Adequacy

NBFCs are generally well capitalised, with the system level capital to risk-weighted assets ratio (CRAR) remaining well above the stipulated norm of 15 per cent. Despite increase in the NPA levels, at the end of September 2019, CRAR of NBFCs-ND-SI and NBFCs-D remained above the stipulated norm despite divergent trends.

F)   Fintech Revolution in India

Fintech revolution in India has not only benefitted banking sector it also propelled the growth in digital lending for NBFCs too. Technology-enabled innovation in financial services challenges the traditional model by lowered costs and vastly expanded financial reach. P2P lending, aggregators and the like have changed the way financial services are being offered, but it is critical to be mindful of the embodied risks. Due to the Fintech partners, there is tough competition to leverage the technology in lending and instant sanctioning process which would benefit to customers in a long way.

With the involvement of Fintech partners there have been advancements in the credit scoring methodology which are based on algorithms in an automated environment, thus resulting in better customer service and credit in an instant manner.

G) Growth to MSME Sector

In addition to banks, NBFCs were instrumental in providing the credit support to MSME sector as defined in the MSME Act. Recently, RBI has issued the interest subvention scheme for MSME Sector to boost the credit flow to them with subvention of interest up to 2%. SIDBI being the nodal agency to manage the subvention scheme under the behest of Government of India. With these schemes, the credit flow to MSME sector would get the boost.

H) Conclusion

With the increasing use of technology, involvement of Fintech partners, more and more digital based model usage, the growth of the NBFCs would be in an accelerated manner. The performance of NBFCs though impacted due to debt defaults due to ALM mismatch in the recent times, the financial performance including profitability especially for NBFCs-D has been showing improving trends. However, the NBFCs-ND-SI would be under constant vigil of RBI to boost the credit acceleration and ensure that the risk to market is minimized. The intervention of RBI such as in the form of subventions would alleviate the fear of the stagnancy in the days to come.

NBFC sector is supplementing the growth of credit in parallel to banks in India and a major catalyst to the development of the country’s financial system. RBI has been constantly focussing on the improvement in the regulatory space to ensure that systemic risk is taken care well and credit crisis is well addressed to NBFCs including the intervention by Government of India. Based on the analysis of the sector, it can be derived that there is long way to go and growth possibilities coupled with the technology can be achieved and NBFCs are on the growth trajectory, by that sense. 

Best regards

CA Abhishek R Sharma

Dec 29, 2019, New Delhi

Interpretations/views are personal

PS – Key fact:

The NBFC sector is dominated by NBFCs-ND-SI, which constitute 86.3 per cent of the total asset size of the sector. Within this segment, government owned NBFCs (particularly the two largest NBFCs i.e., Power Finance Corporation Limited and REC Limited) hold around two fifth of the total assets.

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[1] The Article is based on the RBI Report on Trend and Progress of Banking in India 2018-19 and relevant extract of RBI Report is provided in the article to show case the importance of the facts provided in the RBI report with respect to growth in NBFC Sector. (Source - RBI, 2019, RBI Report on Trend and Progress of Banking in India 2018-19)