By Gaurav Anand
Credit and Finance for MSMEs: NBFCs are increasingly now preferred by borrowers as they not only complement but also substitute banks in their ability to reach remote areas, making quicker decisions, prompt services, and expertise in niche segments. They act as backup institutions when the banking system comes under stress by widening the ambit of financial services and enhancing its resilience. However, this sector calls for regulatory vigil and control on lending rates to thrive economically and provide an architecture to support the financial needs of growing small and medium scale businesses.
Considering the nature of the operation, NBFCs also bear the burden of inherent risks which includes, excess leverage, stripping priority lending sector status from bank to NBFCs, over-reliance on wholesale funding from capital-market or banks, vulnerability to credit risks, inadequate statutory recovery tools, and insufficient benefit from the central banks and amplification of procyclicality. The challenges encountered by NBFCs are several but the Reserve Bank of India (RBI) has looked into the challenges and made some measurable decisions for non-banking institutions.
The operations of NBFCs are regulated by the Reserve Bank of India Act, 1934 with priority given to calibrating regulations and harmonizing them to banking sector regulation thereby reducing the regulatory arbitrage. As per the new regulations to bring regulatory parity with those of banks, NBFCs have been divided into four layers based on their activity, size, perceived risk, and scale-based regulations to help preserve financial stability. The base layer with asset size below Rs 1,000 crore, middle layer with asset size 1,000 crore and above, and an upper layer including top ten NBFC in terms of asset size. Along with that, RBI has also tweaked the NPA classification for NBFCs to 90 days from 180 days and the net-owned fund’s requirement for these NBFcs have been raised to Rs 20 crore from Rs 2 crore which in turn reduces the stress of credit risk and maintaining sufficient liquidity for a smooth transition during the moratorium.
Despite easy accessibility, maximum funding, remote coverage, and improved regulations, NBFCs face a setback of charging a higher rate of interest and processing fees than banks due to its easier and convenient financing options. However, they cannot offer interest rates higher than the ceiling rate given by RBI. The present ceiling rate is 12.5 per cent per annum. Following are the reasons for higher loan interest rates by NBFCs:
Fundraising: Unlike banks, NBFCs do not have a banking license and are not permitted to accept deposits from the public. They, therefore, have to raise funds through various sources like bank borrowings as term loans and also from FDI by selling commercial papers or six-month debt papers. Thus, the interest rate by NBFC has to cover their borrowing cost and the spread.
Non-availability of overdraft facility: Since NBFCs do not offer banking activity, they cannot provide the overdraft facility. This makes their interest payable higher than core banking institutions.
Wider loan eligibility criteria: Applicable LTV (loan-to-value) percentage loan eligibility will be higher for NBFCs in comparison to banks as the former includes stamp duty and registration of assets, unlike banks.
Relaxation in CIBIL score: NBFCs have less stringent policies to rely on CIBIL scores as a criterion to offer loans, unlike banks that require at least 750 credit scores. This makes low-income segments and the informal sector, who do not have a credit history, access loans. This risk pushes NBFCs to charge a higher rate of interest.
Faster process and documentation: NBFCs have a faster turnaround time for loan processing with minimum documentation as compared to banks. The flexibility and convenience are compensated by a higher processing rate.
Importantly, the RBI has been taking up the issue of how non-bank institutions price their loans and has been keen on greater transparency in the process of setting the rate of interest. Moreover, the central bank has mandated the anchor rates for NBFCs to maintain a smooth lending process convenient and affordable for the borrowers. NBFCs have become a pivotal part of the Indian financial system meeting the needs of individuals and SMEs. It accounts for around 9 per cent of total assets of the financial sector, making it the third-largest segment after commercial banks (64 per cent), and insurance companies (14 per cent).
In recent years, NBFCs have become the biggest receiver of funds surpassing banks on a net basis. The enormous growth in credit by NBFCs in the wake of asset quality stress has emphasized their role in India’s financial system. Remaining unserved and underserved by banks, NBFCs are now more focused on developing innovative products and services focused on niche markets at a regulated rate of interest. Partnering with fintechs also have lowered the cost, increased customer base, de-risked customer portfolio, and increased credit penetration for NBFCs in the growing economy.
Gaurav Anand is the CEO & Co-Founder at Namaste Credit. Views expressed are the author’s own.