BS Banking Annual 2018: 'Prepare for growth and margin squeeze'

Over the past 10 years, non-banking financial companies (NBFCs) and housing finance companies (HFCs) have grown from being specialist financiers to companies grabbing market share from banks, especially state-owned ones, in the wake of various issues plaguing the banking sector. However, some of that success has come undone recently in the wake of the defaults by Infrastructure Leasing & Financial Services (IL&FS). Top experts discuss the way ahead for NBFCs. Edited excerpts from the Business Standard NBFC Round Table: 

How do you see the present situation of non-banking finance companies (NBFCs) after the IL&FS problem?

Gagan Banga: There is undoubtedly a crisis. Any financial services company should build its business with the realisation that it will go through a liquidity crisis every three to five years, for one reason or the other. This is the fourth crisis in the last 10 years, and the reason and the trigger every time are different. In the 2008 crisis, banks and mutual funds suffered. In 2013, it was only mutual funds that bore the brunt. We were headed into one in 2016 if it was not for demonetisation. And, in 2018 it was the NBFCs and housing finance companies (HFCs) and mutual funds to some extent which have faced problems. 

The present situation is an outcome of rising interest rates which resulted in massive redemptions over the last 14 months in bond funds of mutual funds. Mutual funds were only receiving money in liquid funds, which by regulations can only put money in 90-day paper. So, commercial paper (CP) issuance increased. A lot of people moved from using CPs for working capital to CPs for growth. And that is why we have this situation. This is a short-term liquidity issue and organisations can easily move on by pausing for three-four months. 

S S Mundra: There could be irrational exuberance as well as irrational pessimism playing out in the markets. This fear around NBFCs today has not come as a sudden revelation. All the parameters of how NBFCs were operating were available but analysts also didn’t realise the problem then. We need to understand that the entity which triggered such a liquidity crisis had a very different business model within the NBFC universe. 

Renuka Ramnath: As an investor for over two decades I can say there is no such thing as easy money in any business. With the proliferation of NBFCs in recent years there have been many amateurs who think that there is easy money to be made. It’s important to have a business building perspective, which big players like HDFC and Bajaj have already demonstrated. So, if people who know how to build businesses enter this space with the right intention, the right time perspective, the right amount of capital, and the right human resources behind them, we would have many ideas which we need in this country.

Jaspal Bindra: The narrative on NBFCs is slightly misunderstood. The need for credit in this market was underserved even when the situation of the NBFCs was good, the public sector banks (PSBs) were firing on all cylinders, and new private sector banks were entering into the market. The demand is growing by the day, and there is huge growth potential for NBFCs, banks and also private equity firms. So, there will be room for supply of credit. No financial institution, be it a global bank, a national bank or an NBFC, is ever going to make enough profit to keep financing itself. They are not going to meet their financing needs through their profits. It’s always going to be through refinance. So, how one manages their financing model is the issue. 

Is there also a problem on the asset side of the NBFCs?

Banga: There are banks which trade at half their book value and there are banks which trade at over five times their book. So, all banks are not the same and similarly, all NBFCs are not the same, and hence we have to differentiate. There may be some players who are ill-disciplined but the larger part of the universe is doing productive work. Four years ago I was faced with a similar situation where people said loans against property (LAP) is a bad word, so I got grading exercises done for all LAPs above Rs 60-70 lakh and we put that out. We also engaged with banks and regularly securitise our loans. We should look at these things more positively.

Mundra: If we look at the data points, 50 per cent of the developer ans are financed by the NBFCs, whereas, the size of the NBFCs compared to the banks is one-fourth. So, there is some concentration of developer loans. It’s quite possible that there are entities which have a problem on their asset side also. But ultimately all boils down to the underwriting practices of the individual. The regulatory framework is quite clear. Also, these entities are subjected to supervision. The intensity of supervision may differ. Technically, as long as these entities are meeting the regulatory definition, I don’t think that kind of possibilities are there.  

Can NBFCs continue to play the important role they have been playing so far?

Ramnath: I still see NBFCs as a very big opportunity. It’s a $300 billion industry which is growing at 20 per cent. The public sector banks (PSBs) have their own issues. They are not going to get capital. The entire growth is being taken by private sector banks and NBFCs. Seventy-five per cent of the growth in the credit system is being appropriated by them. So, NBFCs are not only a great investment opportunity but also a great necessity for the country. We have set ourselves a target to grow from a $2 trillion economy to about $6 trillion in the next 10-12 years. This would mean an incremental credit growth of more than $4 trillion and this is not going to come from the PSBs. It has to come from the private sector, of which NBFCs are a very big component. Banks find it difficult to lend to businesses which do not have hard assets, which is why venture capitalists have made good returns in some places and so have the NBFCs. Going forward, services will be the biggest contributor to our GDP growth where NBFCs have an opportunity. So, I will keep on putting money in the sector.

Banga: Last mile credit delivery in India continues to be a challenge and the NBFCs have been around prior to banks going into prompt corrective action (PCA), and will be around after a large number of these banks come out of PCA. On the aspect of pricing, it is not necessary that you have to compete on the basis of regulatory arbitrage or an asset-liability mismatch arbitrage. One can also compete by getting good investors, having adequate capital, building good credit rating and have multiple number of instruments to finance you.

What is your take on the issue of liquidity and the perception that the Reserve Bank of India (RBI) is not doing enough to address that?

Mundra: The situation is a lot different now from what it was when the crisis unfolded. It is a much more settled atmosphere. Also, within the regulations while the RBI can provide systemic liquidity, to provide targeted liquidity would not be possible within the framework. But there could be ways through which liquidity can be made available.

Have the rating agencies failed in doing their job?

Ramnath: As private equity players we go through huge frustration dealing with the rating agencies. I think their lens needs a complete remake. It’s a lens which was valid 30 years back and has not been remade for the current context.

The sector is under pressure right now, but is also improvement in the short-term debt markets. 

After the crisis, there is a perception that the NBFCs’ credit growth will slow down. Can banks recapture this space back from NBFCs?

Banga: NBFCs will definitely slow down for at least the next 12-18 months, but I don’t think the banks can fill in the space. The last mile credit especially on the retail side that the NBFCs and the housing finance companies are providing is a unique franchise. So, overall, the credit off-take is going to be slightly slower than what it has been in the last 12 months.

Where do we go from here? 

Bindra: I do not think we should paint all NBFCs with the same brush, but in such situations everyone will be exposed to the problem in varying degrees. It is fair to assume that when a sector goes through a lean period, everyone involved in the sector will suffer. We’ve seen it happen in steel because steel went through a longer cycle of low prices than ever before, we are seeing it in power, and in gold and jewellery. 

Mundra: This event will have some positive outcome. First, there will be some consolidation in the industry. There may be some casualties also but within this sector, there are players which have been operating with discipline, with sensitivity towards asset liability mismatch, and with good capital adequacy. So, this is the time when men will be separated from the boys.

On the regulation side going forward there could be changes which may entail some tweaking on the asset-liability management and liquidity side and also some entry barriers. The industry should prepare for growth compression and margin compression for the short term.