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 '17 | Prospects | Sector Do's and dont's]

  • There are 11,522 Non-Banking Financial Companies (NBFCs) registered with the Reserve Bank of India out of which a lion's share of 98.5% are non-deposit accepting with the balance 1.5% being deposit accepting NBFCs. Around 218 non-deposit accepting NBFCs have been classified as systemically important. NBFCs have established presence in specialized segments, for e.g. HDFC (mortgage loans), Mahindra Finance (agri finance), Power Finance Corporation (power finance) & Shriram Transport Finance (pre-owned commercial vehicle finance).
  • Present in the competing fields of vehicle financing, housing loans, hire purchase, lease and personal loans, NBFCs, have emerged as key financial intermediaries for small-scale and retail sectors thereby forming an essential part of shadow banking in India. NBFCs are the third largest segment in the Indian financial system after commercial banks and insurance companies and account for 9% of the total financial assets. Moreover, small and medium enterprise loans account for 10.5% share in the overall credit of NBFCs in FY17. In case of banks, MSE loans accounted for a mere 5.2%.
  • But unlike the shadow banking entities in other countries, NBFCs are regulated by the Reserve Bank of India that has been working towards bringing them at par with the banking regulations. Armed with easier sanction procedures, flexibility, and wide reach in small towns and cities, NBFCs stand on a surer footing vis-a-vis banks.
  • Unlike banks, NBFCs are not required to maintain cash reserve ratio (CRR) and statutory liquid ratio (SLR). Even priority sector lending norm of 40% (of total advances) is not applicable to them.
  • But NBFCs cannot access low-cost deposits like their banking peers. Borrowings make up a lion’s share of 70% of their liabilities, as per CARE Ratings. A number of NBFCs have been issuing non-convertible debentures (NCDs) in order to increase liquidity. For systemically important NBFCs, debentures had the largest share 49% of borrowings in FY17. Bank borrowings and commercial paper account for 22% and 10% in the liability mix.
  • In November 2014, the Reserve Bank of India tightened norms in asset classification and provisioning for NBFCs to bring them at par with banks. The time period after which an overdue asset would be classified as a non-performing was reduced from six months to three months in a phase-wise manner until FY18. Similarly, the time period for classification of sub-standard and doubtful assets was also reduced from 18 months to 12 months. Additionally, the provisioning for standard assets was increased from 0.25% to 0.4% of the outstanding by FY18. These developments have led to an increase in the bad loans and provisions for NBFcs.

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 being 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, base rate requirements are applicable.
  • Bargaining power of customers
  • High, as banks have also forayed into long-term finance and consumer 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 '17

  • Fiscal 2017 continued to be a challenging year for the economy. Sluggish demand continued to pull down capacity utilization and earnings growth of companies, further slowing down capital investments. This adversely impacted credit offtake by India Inc. However, NBFCs with focus on small enterprises continued to outperform banks. The NBFC sector grew its loan book by 13% as compared to 5.4% growth reported by banks in FY17.
  • Despite overall deterioration in the asset quality in the financial system, the NBFC sector managed to keep a check on slippages. Most of the loan slippages in the sector were the bad loans recognised on account of transition to 120 DPD NPA recognition norms. The gross NPA ratio for the NBFC sector rose marginally from 4.5% in FY16 to 5% in FY17. However, the sector’s asset quality is still better than banks that saw gross NPA ratio rise to 9.6% in FY17.
  • Backed by robust loan growth, the NBFC sector posted healthy financial performance registering return on assets (RoA) of 1.8% and Return on equity (ROE) of 6.8% in FY17.
  • The NBFC sector remains sufficiently capitalised with a capital adequacy ratio of 22%, much higher than the minimum regulatory requirement of 15%.

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Prospects

  • As per the Reserve bank of India, the credit intensity measured in terms of credit as percentage of GDP for systemically important and non-deposit accepting NBFCs stood at 8% in 2017. Similarly, their share in the total credit to the commercial sector stood at 8.8% for the year, which reflects substantial potential for growth of NBFCs.
  • NBFCs have been targeting the informal segment consisting of individuals that are either self-employed or employed in the informal sector. But this segment poses asset quality issues. Going ahead, NBFCs will have wider access to consumer data thanks to the new digital-age that will simplify their asset quality concerns as per the BCG report. Moreover, NBFCs can partner with payment banks and small financial banks and provide more financial offerings to customers thereby boosting their growth prospects.
  • Micro small and medium enterprises being under-banked and under-served section of the population present a big growth opportunity for NBFCs. In order to drive employment and consumption, the government has increased focus on expediting the formalisation of the economy. Towards this end, the tax rate on MSMEs with annual turnover of Rs 500 million was reduced to 25% in the last Union Budget. In this year's budget, the tax concession has been extended to MSMEs with annual turnover of Rs 2.5 billion. To alleviate the lending woes of the MSME sector, the government has allocated Rs 37.9 billion for credit support, capital, and interest subsidy. It set a target of Rs 3.3 trillion under Mudra Yojana which provides funds to micro and small enterprises through NBFCs. These initiatives are expected to drive credit growth in the MSME segment.
  • The government’s focus on infrastructure development in the country is expected to provide huge scope to NBFCs engaged in infrastructure financing.
  • As the large exposure regime for the banks will come into effect by 2018, NBFCs will have more room to operate in big corporates financing segment in the medium term. With the development in the equity and corporate bond markets in future, investment companies are likely to have better prospects in future.

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