Top NBFCs have lesser cost of funds than banks

Crisil, the rating agency, said cost of funds for highly rated non-banking finance companies (NBFCs) is less than that for banks.

This means the historical advantage that banks enjoyed over NBFCs where resources are concerned has gradually diminished. Earlier, NBFCs faced a 182 basis points disadvantage in their funding costs vis-a-vis banks' all-inclusive funding cost of 12.75 per cent.

However, the scenario has reversed now with NBFC enjoying a funding cost benefit of 48 basis points vis-a-vis banks' all-inclusive funding cost of 6.53 per cent.

In the past, NBFCs had a significant disadvantage against banks because of the considerable spread that the latter earned on their deployed assets versus their deposits.

The NBFC business model has strengthened considerably over the past few years in terms of their access to varied funding sources. The growth of the mutual fund industry and the emergence of securitisation as a borrowing tool have helped strengthen the NBFC sector.

A break-up of NBFCs sources of funds shows that in FY 2002-03 non convertible debentures & commercial paper accounted for 47 per cent of the total resources raised as against 39 per cent in FY 1999-2000; fixed deposits "" eight per cent (16 per cent); loans from banks and other sources "" 45 per cent (unchanged); and securitisation "" nine per cent (one per cent).

Crisil reasoned that with declining interest rates and falling spreads over G-Sec yields, however, banks funding cost advantage has been wiped out.

This is after factoring in the reduction in the negative carry that banks bear owing to their statutory liquidity ratio and cash reserve ratio investments, which has also fallen because of the decline in opportunity cost of the funds thus deployed, and the operating costs incurred for mobilising their deposits.

"This has contributed in no mean measure in strengthening the business model of these NBFCs," the agency said.

In the past, banks have enjoyed an inherent advantage over NBFCs in terms of raising term deposits at relatively lower costs and raising resources through savings and current accounts.

The southward movement in interest rates since FY 1998-99 has had a twofold impact on banks' cost metrics. Not only has the benefit from low-cost current and savings accounts declined but the spreads on their investments in government securities vis-a-vis their cost of term deposits has also declined.

A flavour of numbers for banks' indicates that the cost of term deposits has declined sharply by about 525 basis points since 1999-2000 in line with the declining trend in the yield on G-Secs, while the yield on G-Secs has declined even more by over 650 basis points.

The interest on savings accounts has, however, fallen by only 150 basis points in the same period.

Crisil believes that this has reduced the benefit that banks enjoyed by virtue of having access to current and savings accounts by 147 basis points. Of this 94 basis points is because of a reduced benefit from savings accounts while 53 basis points emanates from current accounts.

Banks have also been affected by the higher reduction in yields on the investments in G-Secs vis-a-vis their term deposit costs. Historically, banks enjoyed a positive spread on an incremental basis of about 150 basis points on the yield on their investments in G-Secs (of 8-10 year maturity) over their cost of term deposits (2-3 year maturity).

This spread has been wiped out since the last 18 months, partly because of the high liquidity in money market and partly due to the relatively higher decline in yields on G-Secs over the term deposits.

The overall reduction in the banks' gross spreads because of the twin factors of declining interest rates and lower spreads on G-Sec yields is about 297 basis points.

Crisil, however, pointed out that even though the universe of NBFCs rated by it has demonstrated a clear strengthening of their business model, the banking model continues to have several advantages over that of NBFCs.

The rating agency believes that a bank's resource base is considerably more stable because of the high proportion of retail deposits in the total funding base.

Moreover, banks have the potential to earn a significant fee income from transaction banking and other services. Banks have cross-selling opportunities to the large retail population that they tap to raise resources.