By Mukta Malhotra

The going is getting tougher for NBFCs. Earlier, NBFCs were borrowing and lending at higher interest rates. This is changing now. With banks and financial institutions jumping on to the operational turf of NBFCs, lending rates have moved down while borrowing rates remain high. This is squeezing NBFC margins.

So, NBFCs are looking out for sourcing cost-effective funds. Little surprising that sourcing of low-cost funds has become a critical factor in the NBFC survival game.

Problems of perception
NBFCs can source funds from banks and financial institutions. They can raise finance in the form of inter-corporate deposits, debentures, bonds and fixed deposits. Recourse to bank finance is not easy. For, banks continue to hold a negative perception even about well-run leasing and hire purchase companies, who are time-tested borrowers and enjoy good credit ratings. Says Mahesh Thakkar, executive director of the Mumbai-based Association of Leasing and Financial Service Companies: "This is despite the fact that the Vasudev Committee made a strong recommendation for easing the flow of bank credit to NBFCs and the number of positive steps taken by the Reserve Bank of India.

For instance, the Reserve Bank of India has granted priority sector status to banks' exposure to NBFCs for financing against commercial vehicles and small-scale industries." Not just that, the Reserve Bank of India (RBI) has removed the ceiling on the quantum of bank finance to companies in the commercial vehicle and small-scale sectors.

Not a very good news for NBFCs. For, bank credit is expensive. That is why some top-notch NBFCs such as Birla Global Finance are shying away from bank borrowing. Says S K Mitra, managing director of the Mumbai-based Birla Global Finance: "We use bank borrowing occasionally as it comes at a high price." That means even well-placed NBFCs need to explore alternative non-banking avenues of finance.

Expensive deposits
Public deposits are another source of finance for NBFCs. With the RBI allowing only about 600 companies to accept deposits, questions are being raised over RBI's insistence on linking rating to accepting public deposits. Moreover, public deposits too are expensive. That is why quite a few large NBFCs, even those who have access to public deposits, are looking at other sources of finance.

For instance, Birla Global Finance has been whittling down its deposit-base since March 1999 while Alpic Finance has been neither accepting public deposits nor renewing existing public deposits.

There is another side to public deposits as well. Says K V S Manian, chief operating officer of the Mumbai-based Kotak Mahindra Finance: "Though public deposits are expensive sources of finance, they have an advantage. They are unsecured and unencumbered. They can be deployed anywhere unlike bank finance which can be deployed only in hire purchase." Are inter-corporate deposits (ICDs) an alternative source of finance? The answer is no. For, ICDs too come at a high cost.

Non-convertible debentures (NCDs) are of course there. NCD finance can be tapped in a big way, but there are a few problems here as well. NBFCs cannot keep going back to the debt markets as often as required and issuing secured debentures might not be possible for those NBFCs which have small net worth and inadequate assets to offer as security. Debentures can be privately placed. But then that is possible only if the NBFC is large enough. For, sourcing of funds is a spread or volume game. It has to be either a low volume-high spread or a high volume-low spread game. Whatever the complexion of the game, size assumes significance when it comes to NBFCs raising finance.

Swapping of high cost Rupee borrowing to low cost FCNR(B)-backed loans is again a facility that only large NBFCs can think about.

For instance, Alpic Finance has been converting its cash credit facility from Rupees to US Dollars and has thus been able to reduce its borrowing costs from a range of 15-17 per cent to about 12-13 per cent.

That leaves NBFCs with the lone choice of raising equity capital. This equity option can help NBFCs increase their net owned funds and thus raise their fixed deposit mobilisation ceiling. But, there are problems here as well. NBFCs are suffering from an image-crisis. Investors are averse to investing in NBFC equity issues.

Hence, most of theNBFCs cannot think of tapping the equity market for finance. Says Manian of Kotak Mahindra Finance: "The cloud over NBFCs is just about clearing. It is only a matter of time before the capital market gives good NBFCs their due."

Funding strategies
Sourcing of funds might not be a problem for NBFCs backed by large credit-worthy corporate entities. However, even those companies are working out strategies to reduce their cost of funds. Says Manian of Kotak Mahindra Finance: "Our strategy is to see that no single source of finance will cross 20 per cent of our balance sheet."

Alpic Finance has its own way of finding cost-effective funds. Alpic Finance is exploring cost-effective long-term sources of funds such as credit from financial institutions and issuing secured debt instruments including debentures. The NBFC's two privately-placed bond issues, Alpic Infrastructure Bonds and Alpic Liquid Bonds, were a huge success.

Fine. But, if NBFCs are not able to source funds at competitive rates, all their assumptions about future cash flows involving fresh deposits, deposit renewals, premature payment of deposits and pre-closure of loans will go awry. This can disturb NBFCs' asset-liability management and push them into a deeper financial morass.

The securitisation option
In a depressing scenario, there is one silver lining that holds out hope. Asset securitisation can help most smaller NBFCs find solutions to their financing problems. Not just that, even those NBFCs with maturity mismatches can bank on asset securitisation to solve their problems. Asset securitisation is the process by which illiquid loans are converted into liquid and marketable securities.

Over time, securitisation can help NBFCs generate and find resources for creating fresh assets and meeting cash flow gaps. In a declining interest scenario, asset securitisation can also help replace high-cost borrowings with low-cost funds.

Securitisation as a financing option however seems far off. For, there are certain securitisation issues that remain unresolved. One of the major issues that needs to be sorted out is the incidence of stamp duty.

However, securitisation can help NBFCs take assets off their balance sheets. For, in securitisation the originator sells off his assets and these assets are no longer a part of his balance sheet.

Thus, asset securitisation shrinks the asset portfolio of NBFCs and lends a boost to their capital adequacy ratios.

Emerging scenario
External commercial borrowing (ECB) is another finance avenue that has opened up for NBFCs meanwhile. All refinancing of existing ECBs has been brought under the automatic route. Earlier, RBI cleared ECBs under the $5 million scheme and ECBs up to $10 million under all windows. Subject to certain conditions, NBFCs are now eligible for ECBs.

These conditions are: NBFCs should be registered with the RBI, should have earned profits for the last three consecutive years and should have an AA rating from a reputed credit-rating agency. The condition of a three-year profit track record does not apply and even a credit rating of A or equivalent is acceptable, where a credit enhancement guarantee has been provided to an NBFC by its parent on a non-recourse and non-repatriable basis.

This credit enhancement guarantee can help large NBFCs access low-cost funds in the domestic market on the back of a guarantee from a foreign bank or a financial institution or a joint-venture partner. The ECB guidelines are there.

But, NBFCs need to work out long-term financing solutions if they are to stay in the business. Says Manian of Kotak Mahindra Finance: "There are no easy financing solutions for smaller NBFCs.

These NBFCs need to plough back their profits, make their fundamentals strong and get higher credit ratings." That is one sure way to reduce cost of NBFC funds. But, the solution is long-term.