Financial health of NBFCs in India

An analysis of the NBFC crisis, its causes and their current state in the economy

Submitted to:
Professor Charan Singh

Submitted by Group 4:
Navneet Singh Rana PGP09207
Manohar Gupta PGP09157
Margesh Patel PGP09216
Tannu Kumari PGP09054
Vasu Jain PGP09058
Contents
Introduction and Issues........................................................................................................................... 3
Difference between NBFCs and Banks ................................................................................................ 3
What is the NBFC crisis? ..................................................................................................................... 3
Types of NBFCs .................................................................................................................................... 4
Brief Literature Review ........................................................................................................................... 4
Analysis ................................................................................................................................................... 5
How did the crisis start? ..................................................................................................................... 5
Implications of NBFC crisis .................................................................................................................. 6
Conclusions and Recommendations ....................................................................................................... 7
References .............................................................................................................................................. 8
Annexures ............................................................................................................................................... 9

2
Introduction and Issues
A Non-Banking Financial Company (NBFC) is a company engaged in the business of loans and
advances, acquisition of shares, stock, bonds, debentures or securities issued by the
government or other marketable securities of a similar nature, leasing, hire-purchase,
insurance business or chit-fund business. It does not include any institution whose principal
business is that of agriculture activity, industrial activity, purchase or sale of any goods
(other than securities) or providing any services and sale, purchase, construction of
immovable property (RBI Report on Trend and Progress of Banking in India 2017-18)
A non-banking institution which is a company and has principal business of receiving
deposits under any scheme or arrangement in one lump sum or in instalments by way of
contributions or in any other manner, is also a non-banking financial company (Residuary
non-banking company).
NBFCs whose asset size is ₹ 500 crore or more are considered as systemically important
NBFCs. They are given the classification as the activities of such NBFCs will have a bearing on
the financial stability of the overall economy.
NBFCs are registered under the Companies Act, 1956.
Difference between NBFCs and Banks
NBFCs can lend and make investments and thus their activities are similar to that of banks,
however there are a few differences –

 NBFC cannot accept demand deposits

 NBFCs do not form part of the payment and settlement system and cannot issue
cheques drawn on itself
 Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is
not available to depositors of NBFCs, unlike in case of banks
What is the NBFC crisis?
NBFCs are currently facing a liquidity crunch which means they don’t have money to lend or
are facing enormous difficulties in raising funds. Many NBFCs rely on short-term borrowing
to finance long-term lending and thus the current liquidity crunch has put them in a difficult
spot. NBFCs typically borrow money from banks or sell commercial papers to mutual funds
to raise money and lend this money to small and medium enterprises, retail customers and
many others. When NBFCs don’t have money to lend, the credit flow to the economy is
reduced. This hits economic growth and causes many borrowers to default on loans.

3
Types of NBFCs
NBFCs are categorized by type of liabilities (Deposit and Non-Deposit accepting NBFCs), size
(systemically important and other non-deposit holding companies) and by the kind of
activity they conduct.
Table VI.1: Classification of NBFCs by Activity
Type of NBFC Activity
1. Asset Finance Company (AFC) Financing of physical assets including automobiles,
tractors and generators.
2. Loan Company Provision of loan finance.
3. Investment Company Acquisition of securities for purpose of selling.
4. NBFC-Infrastructure Finance Company Provision of infrastructure loans.
(NBFC-IFC)
5. NBFC-Systemically Important Core Makes investments and loans to group companies.
Investment Company (CIC-ND-SI)
6. Infrastructure Debt Fund-NBFC (IDF-NBFC) Facilitation of flow of long-term debt into
infrastructure projects.
7. NBFC-Micro Finance Institution (NBFC- Credit to economically dis-advantaged groups.
MFI)
8. NBFC-Factor Acquisition of receivables of an assignor or
extending loans against the security interest of the
receivables at a discount.
9. NBFC-Non-Operative Financial Holding Facilitation of promoters/ promoter groups in
Company (NOFHC) setting up new banks.
10. Mortgage Guarantee Company (MGC) Undertaking of mortgage guarantee business.
11. NBFC-Account Aggregator (NBFC-AA) Collecting and providing information about a
customer’s financial assets in a consolidated,
organised and retrievable manner to the customer
or others as specified by the customer.
12. NBFC–Peer to Peer Lending Platform Providing an online platform to bring lenders and
(NBFC-P2P) borrowers together to help mobilise funds.
Source: RBI.

Brief Literature Review

The 19th issue of RBIs financial stability report was released on June 27,2019. It reflects the
collective assessment of the Sub-Committee of the FSDC on risks to financial stability, as
also the resilience of the financial system. It also talks about the development and
regulation of the financial sector. The report made an overall assessment of a stable
financial system and an improving resilience of the banking sector. It also stated that the
global economic and geopolitical environment posed challenges to our economy.
The report findings included advanced economies banks easing their monetary policy, weak
private consumption, and a subdued new investment pipeline. On the positive side were
increasing credit growth of Consumer banks, rise in Provision Coverage Ratio of banks,
decline in gross Non Performing Assets, and improving discipline in the NBFC sector.

4
Analysis
Secondary Research
How did the crisis start?
The crisis started with a group company IL&FS Financial Services defaulting on its payment
obligations of bank loans (including interest), term and short-term deposits and failed to
meet the commercial paper redemption obligations due on September 14, 2018. Following
these defaults, rating agency ICRA downgraded the ratings of its short-term and long-term
borrowing programs. The defaults also jeopardized hundreds of investors, banks and mutual
funds associated with IL&FS.
As infrastructure became the central theme in the past two decades, IL&FS had moved
aggressively to lap up projects. In the process, it had built up a debt-to-equity ratio of 18.7.
The group's total debt stood at Rs 91,000 crore. Out of which, nearly Rs 60,000 crore of debt
is at project level, including road, power and water projects. A major reason behind troubles
of IL&FS was complications in land acquisition. The 2013 land acquisition law had made
many of its projects unviable. Cost escalation also led to many incomplete projects. Lack of
timely action exacerbated the problems.

Figure 1. Funding mix for NBFCs

IL&FS have a web of 169 subsidiaries, associates, and joint-venture companies, which made
the default even more worrisome. This had raised concerns about the possibility of
contagion or spillover, with further defaults hitting mutual funds with exposure to IL&FS and
its group companies.
The problem was further compounded by DHFL. Dewan Housing Finance Ltd (DHFL), a major
housing finance company, delayed interest rate payments on June 4, 2019. which had hit
the net asset values (NAVs) of debt funds. Mutual funds had lent to the company in the
5
form of debt securities. The company with a focus on housing finance had reportedly missed
interest payments of Rs 960 crore. Valuation norms require a write-down in the value of
assets in case of such payment delays. This led to a series of downgrades by rating agencies
on its debt over the past two months
Implications of NBFC crisis
Indian economy is currently facing severe challenges both in domestic and international
fronts. A strong drop in consumption and the failure of NBFCs could have major
repercussions across the economy, which is already struggling to deal with the twin-balance
sheet crisis (a high number of non-performing assets and heavily indebted corporates). A
default would lead to an even tighter liquidity crunch, further fears about the viability of
NBFCs, and could have a knock-on effect on numerous other industries.

Figure 2. Number of cancellation of NBFC registrations

As the pressure from banks mounts with an increasing cost of debt, NBFCs started lending
to developers of long term projects and willful corporate defaulters which led to trillions of
rupees locked up in construction, infrastructure projects, and real estate. Promoters were
not able to either borrow more to complete the project or to sell them to others.
Indian Banks that had extended loans to NBFCs, suffered volatility in their stock prices and
their performance was reflected through the change in their share prices. Yes Bank is a
major example which has suffered due to citing its exposure to weaker NBFCs companies.

6
Conclusions and Recommendations
Form our analysis we can conclude that in the short term, growth, margins and asset quality
(for some) will come under pressure. NBFCs with strong support, granular books, diversified
borrowing mix, pricing power and better asset quality will actually emerge stronger in this
turmoil.
NBFCs play an important role in financial inclusion by reaching out to unbanked segments of
society especially MSMEs. Currently, market confidence has downgraded in this sector.
Efforts from RBI and National Housing Bank (NBH) have increased and a deployment of
additional employees to properly investigate and monitor the statutory filings of individual
NBFCs has started. This would contribute to restore confidence in the market.
For NBFCs to realize their true potential there should be a proper trade-off between over-
regulation and under-regulation. It should be on par with global standards. NBFCs should
focus on developing technology and analytics to develop advanced credit scoring models to
ensure proper check of the creditworthiness of lenders
Recent regulatory support like Open Market Operations, securitization push and macro
tailwinds such as lower G-Sec yields and inflation trajectory will bring some relief for the
sector.
Fintech companies are attempting to gain a share of the lucrative opportunity in the Indian
lending market through their mastery of data and technology. Selecting the right
segmentation strategy helps scope and focus the efforts of the NBFC lender on
opportunities that are likely to generate success. NBFCs must make a cultural shift in the
manner they engage with the customer, in order to lay the foundation for a strong
relationship and create a lasting impact. Large NBFCs must consider establishing a dedicated
customer experience function. This can comprise focused resources or cross-function
employee groups who are mandated to drive customer-centricity and buy-ins across
functions Driven by strong financials, increased reach, better understanding of the market
dynamics, down to the local level, and ample growth opportunities, NBFCs will not only
continue but vastly enhance their role in providing credit to the unbanked, under banked
and MSMEs including start-ups.

7
References

RBI’s Report on Trends and Progress of Banking in India

https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/0RTP2018_FE9E97E7AF7024A4B9432173
4CD76DD4F.PDF
NBFCs and PCA framework
https://www.moneycontrol.com/news/business/economy/nbfcs-may-soon-have-pca-like-
framework-report-4243951.html
NBFC Trend and Analysis
https://rbi.org.in/scripts/PublicationsView.aspx?id=18745

ILFS Crisis
https://www.theweek.in/news/biz-tech/2018/09/25/Explained-What-is-ILFS-crisis-and-
how-bad-it-is.html

RBI Financial Stability Report

https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=47426
RBI Governor Speech highlights
https://acadpubl.eu/hub/2018-119-18/3/303.pdf
RBI NBFC report
https://m.rbi.org.in/Scripts/PublicationsView.aspx?id=18745

8
Annexures
Annexure 1

Annexure 2

Annexure 3

9
Annexure 4

Annexure 5

10