Analysis of business model of NBFCs and their future in Indian financial system

Abstract

Non-banking Finance Companies (NBFCs) is an important segment in the financial domain in Indian economy. They provide a diverse set of services to variety of clients, a large number of whom may be outside the traditional banking coverage. In India, NBFCs have played an important role because the traditional banking is limited in geographic reach and does not cater to segments that are deemed to be too risky for them. NBFCs typically look for high yield that comes alone with this high risks. Over the years, NBFCs have evolved significantly and today some of them are as big as small to medium size Schedule Commercial Banks (SCBs). The latest classification of NBFCs as per RBI is: • Asset Financing Company. • Investment Company. • Loan Company. Recently, RBI has added another category called Infrastructure Finance Company (IFC) to this classification. NBFCs are regulated by RBI. Earlier the regulation was mainly focused on deposit taking NBFCs (NBFCs-D) because RBI wanted to protect the public money at stake. Over the years, the non-deposit taking segment has also been growing and RBI has recognized the fact by introducing norms for non-deposit taking but systematically important NBFCs (NBFCs-NDSI). There are significant trends and issues in the NBFC segment. They have been growing fast in size and this is also raising questions about sustainability of their model, especially after the global financial crisis in 2008. Thus there is greater focus on asset liability management and capital adequacy of large players. Recently RBI had come up with a discussion paper on giving new banking licenses and NBFCs, given their financial experience, are considered as frontrunner in this quest. But there are various issues associated with ownership and business models of NBFCs that may undermine their claim as automatic choice for new licenses. The rigors of running a successful and growing financial services business has given rise to the trend of few large companies dominating the segment in various parameters. Large companies are better equipped to handle cycles in the economy, leverage their capital bases and bargain with regulatory bodies and other stakeholders. While typically NBFCs are expected to have portfolios with high risk (denoted by higher NPA) coupled with high yield, some large NBFCs seem to be bucking the trend by maintain NPA at a level comparable with banks while generating consistently high yields on their portfolios. It remains to be seen whether this trend will continue in future. Thus, in future NBFCs can convert into banks or remain as NBFCs and concentrate on their core competencies of serving diverse needs. An alternative future path for NBFCs will be to become Business Correspondents.