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

  • There are 11,682 Non-Banking Financial Companies (NBFCs) registered with the Reserve Bank of India out of which a lion's share of 98% are non-deposit accepting with the balance 2% being deposit accepting NBFCs. Around 220 non-deposit accepting NBFCs have been classified as systemically important. The major NBFCs in India have their relative specializations, for e.g. HDFC (mortgage loans), Mahindra Finance (agri loans), Power Finance Corporation (power finance) & Shriram Transport Finance (preowned commercial vehicle 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 are present in the competing fields of vehicle financing, housing loans, hire purchase, lease and personal loans. NBFCs have emerged as key financial intermediaries particularly for small-scale and retail sectors. With easier sanction procedures, flexibility, low operating cost and focus on core business activity, NBFCs stand on a surer footing vis-a-vis banks.
  • 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 their balance sheet liquidity. Also to address this purpose, especially in the infrastructure 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 advantageous to them, but they do not have access to low-cost demand deposits as in case of banks.
  • In November 2014, the Reserve Bank of India has 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 Asset has been reduced from six months to three months and would be applicable in a phase-wise manner until FY18. Similarly, the time period for classification of sub-standard and doubtful assets has also been reduced from 18 months to 12 months in a phase-wise manner until FY18. In other words, an asset would be classified as sub-standard if it remains NPA for a period of 12 months (18 months presently) and a doubtful asset beyond that. Additionally, the provisioning for standard assets has been raised from 0.25% to 0.4% of the outstanding by FY18. These developments are expected to increase the provisions of NBFCs, going ahead.

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, 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 '16

  • FY16 continued to be a challenging year. Sluggish demand saw investments in infrastructure and core industries coming at a sluggish pace - resulting in poor capacity utilization and slower earnings growth for companies. This has adversely impacted the credit offtake. However, NBFCs continued to outperform banks. The NBFC sector recorded a loan growth of 16.6% as compared to 8.8% credit growth reported by banks in FY16. Robust increase in credit extended by housing finance and microfinance companies contributed to the sturdy growth in the NBFC loan portfolio. This translated into overall balance sheet growth of 15.5% in FY16.
  • Backed by robust loan growth, the NBFC sector posted a healthy financial performance registering an income growth of 15.8% and a profit growth of 15.6%. The profitability of the sector was maintained during the year. The return on assets (RoA) of the sector remained at 2.2% whereas the return on equity (RoE) improved from 10.3% in FY15 to 10.6% in FY16.
  • 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.
  • Despite the overall deterioration in the asset quality in the financial system, the NBFC sector managed to keep a tight check on slippages. The gross NPA ratio for the sector has remained constant at 4.6% during the year.
  • Although the capital adequacy ratio of the sector, fell below 25%, it still is much higher than the RBI limit of 15%.

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Prospects

  • The credit penetration of NBFCs in India at 13% of GDP is still low compared to other emerging economies, according to a report by Boston Consulting Group (BCG). This in turn presents a big untapped opportunity.
  • 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.
  • The revival of economic growth in future backed by government focus on infrastructure development in the country is expected to provide huge scope to NBFCs engaged in infrastructure financing.
  • The conversion of micro finance institutions (MFIs) into small finance is expected to provide space for growth to other NBFCs -MFIs.
  • 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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