Indian Investment & Finance Industry Report - Investment & Finance Sector Research & Analysis in India - Equitymaster

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Investment & Finance Sector Analysis Report 

[Key Points | Financial Year '11 | Prospects | Sector Do's and dont's]

  • With the country's largest development financial institutions (DFIs) like ICICI and IDBI having been converted into banking entities, the term DFI has lost its relevance in the country. Institutions that today have replaced them in playing a vital role in long-term financing and project financing are Non Banking Financial Companies (NBFCs), which have their relative specializations, e.g. HDFC (mortgage loans), IDFC (infrastructure loans), Mahindra Finance & Shriram Transport Finance (auto loans). The trend of segmental monopoly is changing as banks are entering long-term finance and FIs also meeting the medium and short - term needs of the business masses
  • NBFCs have come a long way from an era of concentrated regional operations, low credibility and poor risk management practices to highly sophisticated operations, pan-India presence and as an alternate choice of financial intermediation. Today, NBFCs are present in the competing fields of vehicle financing, housing loans, hire purchase, lease and personal loans. More often than not, NBFCs are present where the risk is higher (hence the returns), reach is required (strong last-mile network), recovery needs to be the focus area, loan-ticket size is small, appraisal and disbursement has to be speedy and flexibility in terms of loan size and tenor is required.
  • NBFCs' growth had been constrained due to lack of adequate capital. Going forward, we believe capital infusion and leverage thereupon would catapult NBFCs' growth in size and scale. A number of NBFCs have been issuing non-convertible debentures (NCDs) in order to increase liquidity in their balance sheets. Also to address this purpose, especially in the infra financing space, a new category of NBFCs was formed called Infrastructure Financing Companies (IFCs).
  • NBFCs are not required to maintain cash reserve ratio (CRR) and statutory liquid ratio (SLR). Priority sector lending norm of 40% (of total advances) is also not applicable for them. While this is to their advantage, they do not have access to low-cost demand deposits. As a result their cost of funds is always high, resulting in thinner spreads. However, the regulatory arbitrage may soon change between the two entities with the help of the Usha Thorat committee recommendations, which call for stricter regulations in the space.

How to Research the Investment & Finance Sector (Key Points)

  • Supply
  • Plenty to meet personal finance needs but not enough to meet long-term infrastructure needs.
  • Demand
  • India is a growing economy, demand for long-term loans, especially infrastructure and personal finance is high.
  • Barriers to entry
  • Licensing requirement, investment in technology, skills required for project finance, distribution reach, minimum capital requirements, etc.
  • Bargaining power of suppliers
  • Providers of funds could be more demanding. As quality of services provided with minimum time matters a lot.
  • Bargaining power of customers
  • High, as banks have also forayed into the long-term finance.
  • Competition
  • High. There are public sector, private sector and foreign banks along with non-banking finance companies competing in similar markets.

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Financial Year '11

  • The RBI is looking at monitoring the NBFC sector to a greater extent now. As per its recent set of regulations, it recently announced that bank funding to and buying of gold loans from (assignment) will not be classified as priority sector any longer. Also as per the latest industry guidelines, only loans to microfinance companies can be classified under priority sector loans.
  • The regulators governing the financing of the real estate sector, the RBI and the NHB (National Housing Bank), clamped down on aggressive lending in the space. In their effort to tame speculation in real estate prices, provisioning norms on all outstanding loans was steeply hiked from 0.4% to 2%. This was irrespective of whether these assets were performing or non performing assets (NPA). Further, if the non dual rate loans turn into NPAs in light of the increased interest rates, the institutions have to make further provisions for the same. Additional regulations on maintaining a certain loan to value ratio and on loan size were also mandated.
  • The RBI announced in its latest budget that will give additional branch licenses to private sector banks and NBFCs that meet the central bank's eligibility criteria. These new licenses should be awarded shortly. A number of NBFCs, microfinance companies and industrial houses are planning to opt for the same.
  • The Budget allocated higher funds for the development of the power sector with a view of speeding up the expansion of new generation capacities. Higher exposure limits for banks to finance UMPPs (ultra mega power projects) and other power projects was granted. Plan allocation for infrastructure sector has been increased by 23% to Rs 2.1 trillion in FY12.
  • Housing finance companies like HDFC and LIC Housing Finance as well as some PSU banks that have extended presence in the semi urban and rural areas will benefit from the interest sops offered on low cost housing loans. The scheme of 1% interest subvention on housing loan up to Rs 15 lakh (Rs 10 lakh previously), where the cost of the house does not exceed Rs 25 lakh (20 lakhs) has been extended up to March 31, 2012, benefitting these players.

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  • The mortgage penetration continues to remain abysmally low - in India the mortgage to GDP ratio is at around 9% (in FY11) against over 80% in the USA. Even if one were to benchmark against more comparable counterparts, the ratio ranges between 20% (China) to 41% (Hong Kong) for most South East Asian nations.
  • Since March 2010, the RBI was on the offense, raising key policy rates 11 times. The current interest rate environment is putting pressure on the margins of financing companies and is also leading to a slowdown in GDP growth and infra activity in the country.
  • The power sector has also been facing myriad issues right from coal linkages and land acquisition worries to environmental concerns. Slowdown in the infrastructure space due to the central bank’s aggressive interest rate policies also did not help matters much for power and infrastructure financiers including REC, PFC and IDFC.
  • According to the recommendations of the Usha Thorat committee, the core Tier-1 capital ratio for NBFCs needs to reach 12% over the next three years. Thus if these recommendations are accepted, companies will have to shore up their capital sufficiently to account for growth as well as regulatory requirements. Provisioning and other norms may also be brought similar to that of banks in a phased manner.
  • As per the committee, risk weights for NBFCs not sponsored by banks or that do not have any bank as part of the group may be raised to 150% for capital market exposures and 125% for commercial real estate exposures. Thus, there are a number of regulatory concerns that still need to be ironed out with regards to this space. However the prospects of certain players receiving a banking license, and limits on risky exposures, and maintaining capital buffers are welcome reforms.

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