Introduction
Non-Banking Financial Companies (NBFCs) are also known as shadow banks. There are more than 9,500 NBFCs registered with Reserve Bank of India (RBI). The Non-Banking Financial Companies (NBFC) sector in India has seen many highs and lows to reach where it is today. Their scale of operations and diversity in financial intermediation are testimony to their adaptability in transforming their business models, understanding needs of a growing economy and the fast changing regulatory norms. NBFCs complement banks in the credit intermediation process by offering diversified, tailor-made financial products through innovative service delivery mechanisms. Furthermore, they facilitate financial inclusion by providing credit to unbanked sections of the population in different geographical areas and different business segments whether its Manufacturing, trading or services; whether it’s in B2B (wholesale) or B2C (retail) business. Over the years, NBFCs have assumed systemic importance due to their inter-linkages with the banking sector, capital market and other financial sector entities. NBFCs’ credit to Gross Domestic Product (GDP) ratio increased from 8.6 per cent in 2012-13 to 12.2 per cent in 2018-19 before moderating slightly to 11.6 per cent in 2019-20 in the wake of the pandemic as per Reserve Bank of India reports.
India has always been home to a vibrant spectrum of microenterprises even before that term became popular in mainstream economics. The small business sector in India is deeply rooted in familial customs and niche skills. Today, that sector has been recognized as a legitimate business sector with its own set of nuanced workings. This sector now includes 51 million microenterprises, each with its specific need for credit. These microenterprises were traditionally not financed by banks due to the need of too many financial documents and credit records. Non-Banking Financial Corporations (NBFCs) are offering more interesting propositions to these microenterprises. NBFCs are playing an increasingly important role in the growth of microenterprises.
In terms of distribution of number of companies, non-systemically important non-deposit taking NBFCs (NBFCs-ND) with an asset size of less than ₹500 crore have a large share 9,100 or 83% of total NBFCs. A non- deposit taking NBFC with asset size greater than ₹500 crore is considered systemically important (NBFCs-ND-SI). In terms of total count they are only 292 however in terms of assets, NBFCs-ND-SI constituted around 83 per cent of the total assets of the sector.
Challenges
The NBFC sector which was booming as a favorite investment destination till 2017 witnessed some challenges in the form of Demonetization, implementation of GST which were somehow met by the industry successfully. However, NBFCs faced liquidity and trust issues in September 2018 when some large NBFCs witnessed huge ALM (Asset and Liability Management) gap coupled with other serious concerns; this not only resulted in larger investors and banks to stop providing liquidity to other NBFCs but also created panic in the market. The market also witnessed several more NBFCs getting downgraded by rating agencies and having corporate governance issues.
The IL&FS default in September 2018 impacted market confidence and resulted in liquidity stress and higher borrowing costs for NBFCs. The Reserve Bank strengthened its regulatory oversight over the sector, and NBFCs also took proactive steps in correcting asset-liability mismatches. NBFC credit grew even after the IL&FS default, though at a slower pace, aided by bank borrowings and supportive policy measures. However, just as the NBFC sector was finding its bearings, the COVID-19 pandemic struck and exacerbated the challenges faced by the sector.
Why microenterprises favor NBFCs
Microenterprises are generally categorized under the riskier borrower segments of banks. While many banks have their own MSME (Micro, Small and Medium Enterprises) divisions, their drive towards evaluating the low-credit health applications of microenterprises is limited. The reason for the low-credit health is the non-availability of the traditional means of collateral.
NBFCs are however, more innovative towards the evaluation of the credit risk. Factors like the business stability (which may be undocumented), family repute, product idea or market monopoly are hard to weigh on a credit scoring scale. NBFCs today carry the expertise and the technology to evaluate these seemingly unquantifiable parameters and arrive at an informed decision about the credit health of microenterprises. The banks generally fail to make such judgments or find the loan application to be too risky by their measures.
Due to this difference in the approach towards lending, the banks’ total share in the loan market fell from 49% to 28% according to a report (https://www.bcg.com/documents/file15284.pdf) by the Boston Consulting Group. The same report also states that the share of NBFCs rose from 21% to an impressive 44%. This happened in just three years, between 2014 and 2017.
NBFCs are also being favored by the younger entrepreneurial populace, which has taken a liking to the lesser bureaucracy and flexibility of NBFCs. The same report states that NBFCs had the lion’s share of the market for loans to persons aged between 21 and 35, at 49%.
Why NBFCs favor microenterprises
Most microenterprises seek loans under project finance, equipment finance or loan against property (LAP). In these three categories, LAPs are the most popular amongst microenterprises, where the business owner’s residential or commercial property is put up as collateral. The rate of delinquency for microenterprises are in the range of 7.4% to 8.1% as against the much more discouraging figures of 12.25% to 22.3% for large corporates. This is ironic because, microenterprises get routinely turned down to their perceived credit health issues, the keyword here being ‘perceived’. NBFCs favor microenterprises because they have the analytics to tell them the real story and not just consider the presence of large office space or employee strength.
NBFCs are also generally working with lesser opex, more flexibility and greater agility. These factors lead to NBFCs being comfortable with the microenterprise lending arena, which would generally discourage a bank. Microenterprises also offer partnership options or profit-sharing options to NBFCs that seem attractive because of the entrepreneurial spirit that NBFCs yearn to kindle. These kind of benefits are different from the traditional money-lending advantages, that NBFCs make ample use of.
The introduction of the Goods and Service Tax (GST) is a move that has placed the transactions of many undocumented microenterprises on the map. NBFCs are able to view the business activity of a microenterprise with much greater clarity than before.
NBFC 2.0 are attracting more microenterprises
The marriage of financial technology and the existing set of financial services that NBFCs provide is churning out more futuristic companies that are said to be a part of NBFC 2.0. These companies are using a mix of different analytics’ tools to conduct their credit health check. By checking the website traffic of the microenterprise, the social media activity, the track record of the entrepreneurs, the innovation introduced in the product or service, NBFC 2.0 is processing loan applications at a much quicker pace. This is helping the growth of microenterprises which in turn feeds back to the growth of NBFCs. NBFCs are also growing in terms of technology and expertise and not just size. This growth is helping them become better at providing financial services to microenterprises.
In the last few years Reserve Bank of India (RBI) has come out with various guidelines to improve the working of NBFCs.
– Merging of housing finance companies with RBI: the housing finance companies or home loan companies which were regulated by National Housing Bank (NHB) have now been brought under RBI for regulation purpose.
– A new category of NBFCs Account Aggregators (AA) have been introduced, this category is expected to have better data of all borrowers and provide the same digitally for better underwriting and information flow.
– New scale based regulation for NBFCs: RBI has proposed to regulate NBFCs based on the asset size; they are named as Base Layer, Middle Layer, Upper Layer and Top Layer; a short definition of the same as below: –
Base Layer
The Base Layer shall comprise of (a) non-deposit taking NBFCs below the asset size of ₹1000 crore and (b) NBFCs undertaking the following activities- (i) NBFC-Peer to Peer Lending Platform (NBFC-P2P), (ii) NBFC-Account Aggregator (NBFC-AA), (iii) Non- Operative Financial Holding Company (NOFHC) and (iv) NBFCs not availing public funds and not having any customer interface.
Middle Layer
The Middle Layer shall consist of (a) all deposit taking NBFCs (NBFC-Ds), irrespective of asset size, (b) non-deposit taking NBFCs with asset size of ₹1000 crore and above and (c) NBFCs undertaking the following activities (i) Standalone Primary Dealers (SPDs), (ii) Infrastructure Debt Fund – Non-Banking Financial Companies (IDF-NBFCs), (iii) Core Investment Companies (CICs), (iv) Housing Finance Companies (HFCs) and (v)Infrastructure Finance Companies (NBFC-IFCs).
Upper Layer
The Upper Layer shall comprise of those NBFCs which are specifically identified by the Reserve Bank as warranting enhanced regulatory requirement based on a set of parameters and scoring methodology. The top ten eligible NBFCs in terms of their asset size shall always reside in the upper layer, irrespective of any other factor.
Top Layer
The Top Layer will ideally remain empty. This layer can get populated if the Reserve Bank is of the opinion that there is a substantial increase in the potential systemic risk from specific NBFCs in the Upper Layer. Such NBFCs shall move to the Top Layer from the Upper Layer.
In new development the tech-enabled of Fintech NBFCs are using India stack 2.0 with extensive use of GST data and other data available through government sources. The companies are fast adopting Video KYC, Video PD and digital signatures for faster and better services to their customers.
Conclusion
NBFCs will continue to do better in the microenterprises’ arena compared to their banking counterparts. They already have a competitive market share that is only expected to grow as microenterprises become more familiar to the nation and the economy.
The quickness to respond, utilization of technology, analysis of non-standard credit health aspects and desire to innovate will make NBFCs, preferred choice for credit for microenterprises.
In my view three (03) Vs shall decide the dominance of NBFCs who adopt them faster, these are (1) Voice (2) Video and (3) Vernacular. And extensive use to technology shall put NBFCs far ahead of banks or convert them to digital banks.
Prest Loans (www.prestloans.com) is a new age Fintech NBFC that uses technology and analytics to provide easy finance options to MSMEs.
Ashok Mittal
Founder & CEO
Prest Loans
