WHITHER NBFC's?
Dr Ranjan Das
Professor of Strategic & International Management, IIM Calcutta Consulting Editor, Strategic Marketing
Raveendra C.
Doctoral Research Scholar, IIM Calcutta

On-Banking Financial Companies (NBFCs) are a set of financial service companies that are quite unique to India in terms of their size and the range of services provided by them. The services provided by NBFCs range from retail service such as loans, leasing and hire purchase financing, brokerage and distribution services; to bill discounting and syndication services to corporate customers. Till early 1990s, when NBFCs were at their peak, most retail customers would approach an NBFC rather than a bank for all their financial service needs. However, since its peak in the mid-1990s when public deposits held by NBFCs increased to 9.5 per cent of bank deposits, this sector saw a steep decline. Aggregate public deposits of NBFCs as a percentage of bank deposits came down to 1.5 per cent by March 2003 (See Table 1).

What were the reasons for such a sharp decline?

Will NBFCs continue to play a role in the financial economy of India?

What are the strategic options for NBFCs if they have to survive and grow?

This article attempts to analyse some of these issues.

BACKGROUND
Till 1990s, NBFCs constituted a significant part of the Indian financial services industry and complemented the services provided by a bank. They were a heterogeneous group of intermediaries of varying size and provided a range of services. They were characterised by their ability to provide niche financial services and due to their relative organisational flexibility, they were often able to provide tailor-made services relatively faster than banks and financial institutions. This enabled them to build up a wide-ranging clientele from small borrowers to established corporates.
Based on the principal activity carried out by the company, NBFCs were classified by RBI under five main categories - Equipment leasing company (EL), Hire Purchase finance company (HP), Investment company (IC), Loan company (LC) and Residuary non-banking company (RNBCs - large companies not coming under any one particular category). Table 2 gives the activity-wise distribution of assets of NBFCs. Hire purchase finance, mostly consisting of retail funding of cars, commercial vehicles and consumer durables was the primary activity, followed by loans and inter-corporate deposits.
NBFCs achieved their zenith in early 1990s. Their accelerated expansion in 90s was driven by the opportunities created by the process of financial liberalisation. However, their rapid growth resulted in unhealthy practices and certain disconcerting developments. In response to this, RBI considerably tightened its supervisory and regulatory framework over NBFCs in 1998. Some of the new measures of
Hire purchase finance, mostly consisting of retail funding of cars, commercial vehicles and consumer durables was the primary activity, followed by loans and inter-corporate deposits
Amain categories - Equipment leasing company (EL), Hire Purchase finance company (HP), Investment company (IC), Loan company (LC) and Residuary non-banking company (RNBCs - large companies not coming under any one particular category). Table 2 gives the activity-wise distribution of assets of NBFCs. Hire purchase finance, mostly consisting of retail funding of cars, commercial vehicles and consumer durables was the primary activity, followed by loans and inter-corporate deposits.
NBFCs achieved their zenith in early 1990s. Their accelerated expansion in 90s was driven by the opportunities created by the process of financial liberalisation. However, their rapid growth resulted in unhealthy practices and certain disconcerting developments. In response to this, RBI considerably tightened its supervisory and regulatory framework over NBFCs in 1998.

Some of the new measures of RBI included:

• l NBFCs with net owned fund (NOF) of less than Rs. 25 lakh (with or without credit rating) are not entitled to accept public deposits.
• l The un-rated and underrated (rating below the minimum investment grade) NBFCs in the category of equipment leasing and hire purchase finance companies with NOF of Rs. 25 lakh and above are allowed to accept public deposits up to 1.5 times of their NOF or Rs. 10 crore, whichever is less, provided their CRAR (Capital to risk-weighted assets ratio) is 15 per cent or above.
• l The un-rated and underrated NBFCs in the category of loan and investment companies, irrespective of their NOF and CRAR, are not entitled to accept public deposits.
• l NBFCs in the category of equipment leasing and hire purchase finance companies with NOF of Rs. 25 lakh and above as well as minimum investment grade credit rating can accept public deposits four times of NOF provided they have CRAR of not less than 10 per cent as on 31.3.1998 and shall have CRAR of not less than 12 per cent as on 31.3.1999.
• l NBFCs in the category of loan and investment companies with NOF of Rs. 25 lakhs and above as well as minimum investment grade credit rating can accept public deposits not exceeding 1.5 times of NOF provided they have CRAR of 15 per cent or above with immediate effect.

DECLINE OF NBFCs
The stringent controls by RBI as well as increasing competition from the rejuvenated banking sector (which was opened up for private players in early nineties) had an adverse impact on NBFCs. Most of the smaller NBFCs could not withstand the pressure and closed down. The overall NBFC sector, except RNBCs, which are large with a broad business mix, recorded losses. The following were some of the main problems faced by NBFCs3.

1. High cost of funds
2. Stiff competition with NBFCs as well as with banking sector
3. Small balance sheet size resulting in high cost of funds and low asset profile
4. Inability to raise funds due to RBI restrictions
5. Non performing assets

Cont....