Non-banking Finance Companies: Ushering Financial Inclusion

Date:   Thursday , February 02, 2017

Magma Fincorp (NSE: MAGMA.NS) is an RBI registered non-banking financial company offering a wide portfolio of financial services such as vehicle finance, construction finance, housing loans, SME loans and Insurance services, to name a few. It has a current market capital of Rs.2314.84 crore.

Non banking finance companies (NBFC) form an intrinsic part of the Indian financial system. They contribute to both nation building and financial inclusion by providing credit to those who are not covered by the formal banking sector. NBFC as a sector is now being recognized as an important part of the financial system and has shown consistent growth of 19 percent compounded annual growth rate (CAGR) over the past few years.

The NBFC players cater to the new to credit customers who do not have repayment track records or banking habits; largely in the commercial vehicles, tractor, SME, and used vehicles segment. NBFCs have over time developed a strong platform to assess the profile and credit needs of an unbanked borrower supported by a robust collection mechanism to ensure that their portfolio behavior is under control. As of 2016, NBFCs have by and large proven to be more profitable than conventional banks due to higher yields and better portfolio behavior.

The traditional banks, with increasing bad debts, are finding it more and more difficult to lend, especially in rural areas, presenting an opportunity to NBFCs to reach out to rural areas. NBFCs have succeeded due to better and more relevant products, lower cost, greater reach, strong risk management capabilities, and deeper understanding of customer segments. Apart from traditional segments like passenger and vehicle finance, they are managing to build considerable assets in the personal loan and housing finance sector.

In the consumer finance segment, increasing urban demand, greater disposable incomes due to effective government schemes and 7th pay commission will continue the growth trajectory in urban areas, but the picture may not be so bright in the rural areas. In small and medium enterprises (SME) sector, there is an increase in business and professional loans, but this is not so in loan against property due to greater competition from new entrants as well as from traditional banks. In the commercial vehicles (CV) segment, regulatory changes such as scrapping of old CVs and Bharat stage VI pollution norms is expected to increase growth in the pre-owned CV sector.

A large country like India needs to provide greater financial access for increasing growth and entrepreneurship. The government and regulatory bodies are facilitating this process through schemes such as the Pradhan Mantri Jan-DhanYojana, granting in principle licenses to several players for establishing specialty banks. Industry bodies such as the National Payments Corporation of India (NCPI) are seeking to make the payments ecosystem robust by launching the Unified Payment Interface (UPI), and Bharat Bill Payments system. NBFCs can take advantage of such systems and players by forming partnerships with payment banks and bill payment providers that will enable them to provide the entire range of services, from deposits to lending, investments and transactions.

The other major factor is the encouragement by the government and the adoption of digital as a way of life by the Indian consumer. NBFCs need to move with the times by adopting suitable strategy to improve pricing and positioning of product portfolio, improving internal and customer facing processes, and end-to-end customer interaction. Credit penetration in India is limited due to absence of income proofs/IT returns because of temporary/self employment. NBFCs should use digital and social media data as substitutes for such documents to make better credit decision. To achieve this, they will need to invest in technology and analytics to develop advanced credit scoring models that make use of both traditional and non-traditional data sources. They will also need to develop credit risk models based on behavior that include social graph, employment records, personal network and educational qualifications. An important source of credit information is mobile phone records. Indians are the second largest mobile phone users in the world. Whenever they use the phone, they leave a digital footprint that can be used to assess consumer risk and determine the credit worthiness of underserved customers.

It is also important that the regulatory framework keeps pace with the developments in the sector so that they play a facilitating role in the growth of NBFC\'s. There was a suggestion to shift from entity based regulation of NBFC\'s to activity based regulation. RBI is expected to bring in regulations for consolidation of different types of NBFCs. There is also no clarity on the core investment companies\' regulations issued by the RBI. The RBI\'s draft regulatory framework on account aggregator NBFCs will perform the function of consolidating all financial information of a person across banks, insurance companies, mutual funds, and others, in a common format.

The government is also taking steps to harmonize the provisions of the regulations for foreign direct investment in an NBFC with the RBI-NBFC directions. The government has permitted foreign investment through automatic route in \'other financial services\', if they are under regulators like RBI and SEBI. 196 systematically important NBFCs with assets of Rs.500 crore or more have been notified as \'secured lenders\' under the Securitisation and Reconstruction of Financial Assets and Enforcementof Security Interest Act, 2002, (SARFAESI Act). This would help in creating a level playing field for NBFCs with banks.

NBFCs are an important component institution in the macroeconomic scenario and a core catalyst in the Indian financial system. They are evolving as a better alternative to traditional banks for meeting the financial needs of various sectors. In order to continue to grow, they will have to focus on their strengths and work on weaknesses. They will have to constantly work on introducing new products and services to compete in the market. Finally, an appropriate and dynamic regulatory framework by the RBI would go a long way in ensuring that NBFCs continue to play the vital role in the Indian financial system. It is expected that the improving macroeconomic conditions, greater credit penetration, increasing consumption and disruptive digital trends will allow NBFCs credit to grow at a healthy rate of 7-10 percent.