The last one year has been a reality check for non-banking financial companies (NBFCs). With a decline in supply of money, rising cost of borrowing, increasing questions on governance following high-profile defaults and slowdown in consumption impacting auto sector the most, the lending industry is faced with a number of challenges.
Adding to the troubles are difficulties faced by fintech companies with new models, emergence of machine-learning based analytics and a traditionally uneven playing field between banks and NBFCs with lower support levels to NBFCs.
The first two challenges – supply and cost of money – are cyclical. For many years, the NBFC space had access to funds at a few basis points above sovereign debt cost. Easy access to cheap liquidity probably spurred less vibrant and sustainable business models.
As results that have panned out over the last year or so reveal, banks have withdrawn unused credit lines to NBFCs, showing their reluctance to renew existing credit lines.
Maybe it is a bit sudden and extreme, but in the near future, this situation will correct itself and good companies will continue to access adequate lines of credit at reasonable prices.
In order to address these challenges, companies will need to take a hard look at operating models based on cheaper distribution, better underwriting and sharper collections, all backed by a firm layer of analytics to adjust to a new normal.
If borrowing costs drop, it will augment profitability, but lending models cannot be built purely on the back of easy and cheap funds. To that extent, the challenge is good and will only strengthen lending models in the medium term.
The industry will need to address the challenge of asset-liability mismatch by potentially re-engineering product portfolios in line with the tenure of borrowing.
The challenge of governance is more a perception than reality. Regulatory framework, audits by the regulator, board participation in implementing governance and implementation of company-level risk heads, the wireframes are all in place.
Lenders that intend developing and sustaining robust models have always paid adequate heed to good governance. What the industry needs to do is to work on far stronger interaction forums with the regulators and government ministries that look at this ecosystem, showcasing implementation of governance models more robustly.
The challenge of an uneven playing field remains, though the gaps are closing. Accounting standards and asset-side benchmarks are areas where banks and NBFCs are starting to resemble each other more and more.
Talking of positives, there is clear visible support. The Union Budget acknowledged and appreciated the role of NBFCs in the financial system and the need to provide funding support to them.
It also announced that the government of India shall provide the first loss guarantee to banks on NBFCs’ pool of assets up to the total value of Rs 1 lakh crore, thereby reposing immense confidence in the strength of the sector.
Recently, the RBI allowed all bank lending to NBFCs to be treated as priority sector lending (PSL) by banks. This gave a huge incentive to the banks to lend to NBFCs. While it ensured sufficient bank funding to NBFCs at a reasonable cost, it also facilitated banks to meet their PSL targets.
A challenge that comes as an opportunity is the emergence of fintech players, who are backed by deep neural learning and AI. This is indeed a wake-up call for the NBFC segment. Companies with older models will learn to disrupt their templates from within or will co-opt new-age players through strategic partnerships or tie-ups.
All this will mean better access to customers, leaner operating models and speed of delivery at a very different level.
It is worth mentioning that in a country with 1.3 billion people, India’s household-to-debt ratio is 11 per cent as compared to a staggering 60-120 per cent in many developed and emerging economies.
With such a vast canvas and growing appetite for credit, NBFCs will continue to play a key role, catering to the needs of the customers in Tier II and III towns, addressing first-time borrowers, clientele with little or no proper documents or banking history and truly being part of the journey to create an inclusive financial ecosystem.