NBFCs: Oil slick ahead

Srikesh P Menon

When one hears of non-banking finance companies (NBFCs), the first thing that comes to mind is a business that has been going through rough waters for nearly half a decade.

And things only appear to get worse. Sample this. The negative credit-risk profile of NBFCs has been heightened by difficult business conditions, regulatory changes regarding deposit-acceptance, provisioning for non-performing assets (NPAs), increased competition, deteriorating asset quality, increased asset-liability mismatches and dwindling resource raising options. NBFCs are also experiencing a marked slowdown in disbursements due to a combination of sluggish demand for credit, funding constraints and increased competition from international players and banks.

Says the Credit Rating Information Services of India Ltd’s (Crisil) head of financial sector ratings, D Thyagarajan: "The shakeout in the NBFC industry during 1996-98 saw the exit of a number of marginal players from the business, resulting in the industry being dominated by a handful of large local and multinational players. The remaining in the industry are either strong enough on their own or have the backing of a business group or a multinational parent. This meant that these players had the holding power to ride out business cycles and the financial strength to absorb losses and restructure business focus."

To get an overview. Some players like Hinduja Finance have tried to reposition telecom-media-technology players. Citing a new revenue model, they have tried to raise monies riding the boom in the technology and allied sectors. A much-talked-about private placement deal with Bank of America (BankAm) never happened. Alpic Finance is looking at a revenue model: broadly as a non-asset player. Others like Atul Nissar of the erstwhile Apple Finance also had new plans.

The liquidity position of most NBFCs has been impaired by the necessity to reduce deposits to be in line with the Reserve Bank of India’s (RBI) guidelines. They also find it difficult to obtain significant increase in bank finance. And given the state of the bourses, NBFCs have not been able to recapitalise themselves, which has resulted in increase in leveraging levels for the industry.

"Competition has intensified with the entry of financial institutions and banks into businesses, which were more or less the exclusive domain of NBFCs earlier," says Kotak Mahindra Finance Ltd executive director Dipak Gupta.

"With the entry of banks, this sector has been the most hurt as banks lend funds at lower rates since they can borrow at lower rates. As a result, NBFCs have to opt for lower rated borrowers, which in turn increases the risk factor. The overall economic slowdown also has negated any chances of a near-term recovery for NBFCs," adds Mr Gupta.

This had led to profitability coming under increasing pressure. The quality of asset-financing NBFCs have exhibited an overall improvement in the last few years. This is, inter alia, due a combination of factors like a drastic reduction or in some cases, a complete exit from the corporate plant and machinery segments. These were main contributors to NPAs. Improved credit appraisal and credit monitoring systems have helped too.

"The above scenario is clearly reflected in Crisil’s rating-action of NBFCs over the last few years. Not only has the average rating of the NBFC sector been higher than the pre-shakeout era, but the ratings have also been relatively more stable," Mr Thyagarajan points out.
With the shakeout and exit of several large players, the NBFC-landscape regarding the asset financing business has altered considerably. Among the existing large NBFCs, Citicorp Finance, GE Capital, Kotak Mahindra, GE Countrywide and Associates along with Ashok Leyland Finance, M&M Finance, Citicorp Maruti Finance and Bajaj Auto Finance are a few which have managed to survive in a depleting industry. Recently, Tata Finance, one of the largest NBFCs, ran into problems due to mismanagement of funds by its internal management.

More by way of shakeout is on the cards with several foreign banks setting up NBFCs. Notable names in recent times include ABN Amro Bank and BankAm. In the Union Budget for 2000-2001, finance minister Yashwant Sinha has allowed 100 per cent foreign-owned NBFCs if players were to pump in $50 million. Analsyts point out that if the market improves, many will do so. The only hitch being that the regulation is out of sync with reality. Earlier, a player had to cough up $5 million for 74 per cent, but under the new dispensation, it is $45 million for the additional 26 per cent!

Again, normally after a shakeout and consolidation, pressure on margins can be expected to ease with reduced numbers. However, the NBFC sector today is dominated by large sized players with deep pockets, ambitious growth plans and aggresive approach to increase market share.

The unregulated NBFC segment has been cleansed by the powers that be -- 40,000-odd unregistered NBFCs, which mushroomed in the mid-90s have been brought down to a managebale 700 odd.

Alpic Finance Ltd executive director TS Chandrashekar points out to the profile of players: a "finance" NBFC; a plantation company, which is not an NBFC; an RNBFC; a securities company; and a manufacturing company accepting deposits, which is not an NBFC.
Besides these, there are Chit Funds; unincorporated bodies raising monies from investors. And investors are simply not able to differentiate.Mr Chandrashekar suggests that there is an urgent need to get a law which differentiaties between a deposit-taking institution and non-deposit taking institution.

The Association of Leasing & Financial Services Cos executive director Mahesh Thakkar echoes a like view. He also suggests that the RBI should take more stringent steps to curb defaults and cheating. The process of rating of NBFCs, which qualifies them to raise deposits should be dispensed with and the regulator -- RBI -- should give approvals based on inspection of the respective NBFC to either raise deposits from the market place or not.

Mr Thakkar is of the view that NBFCs should be given new names to distinguish: equipment leasing, hire purchase companies, and finance companies. Along with this, banks should be liberal in funding NBFCs. The SLR should be reduced from 15 per cent to 10 per cent, and that deposit raising capacity for unrated NBFCs be increased from 1.5 times to four times.

There are other issues as well. Mr Chandrashekar suggests that debt recovery tribunals, which have been relatively effective as compared to proceeding in civil courts, be thrown open to NBFC segment.

Going forward, the trend in terms of profitability pressures and steady asset quality is not likely to be very different. There is also a need to examine the issue of insurance on the lines of that which exists for banks.

Mr Thakkar had requested the RBI to exempt NBFCs registered with RBI from contributing at the rate of 0.005 per cent to 0.1 per cent on the value of annual turnover of every company to a specialised fund, which would be used for the purpose of rehabilitation or revival or protection of assets of a sick industrial company.

Mr Thakkar’s justification for the exemption was that NBFCs are the first victims of "industrial sickness" and several pulled down shutters because of non-payment of their dues by such sick units. Also, NBFCs do not enjoy a level-playing field with the rest of the financial system. And hence they do not get a tax break on provisioning completed as per RBI regulation, whereas credit grantors, be they a bank or a financial institution, do get tax breaks on provisioning completed by them.

And what’s the verdict? "It’s a tough going for NBFCs and it will take at least another couple of years for some kind of stability. The choice for NBFCs to survive is either to match banks and live with lower margins or opt for poor-credited borrowers, which, in turn, increases the risk factor," opines Mr Gupta. True words!