Will NBFCs mimic old private sector banks? 

About seven years ago, there were five leading non-bank large housing financiers – HDFC, Indiabulls Housing, LIC Housing Finance, Dewan Housing Finance Corporation and PNB Housing. The market capitalisation of Dewan or Indiabulls Housing was larger than several public sector banks combined. Growing at a galloping pace, far exceeding that of banks, money was chasing India’s non-banking finance companies (NBFCs), just like its flowing into fintechs now.

Cut to the present, among housing financiers, Dewan is out of the picture. Indiabulls Housing had to entirely revamp its business model to stay in the game. PNB Housing remains embroiled with its fund-raising plans, literally leaving the space to be shared between two players.

After surviving the IL&FS crisis, the current environment seems to be the real test for NBFCs. Insolvency proceedings are underway at Reliance Capital and SREI group, while Magma and Altico, despite finding a new buyer, are yet to get back on the map. L&T Finance is entirely redoing its business strategy to regain presence in the market. In short, each player is forced to revisit its business model to adapt to today’s environment.

Changing dynamics

Business came to a halt for six months till August 2020, thanks to the pandemic. Whether growth, collections or liquidity, there were problems on all fronts. While the last aspect has been addressed due to the regulator’s interventions, it hasn’t been easy for NBFCs to regain their ground. This time they had to fight an unprecedented threat – banks.

Not that competition from banks is new. But until 2020, NBFCs had a sense of complacency that products such as home loans for resale properties, gold loans, SME lending, loan against property (LAP) were their foothold. Banks couldn’t encroach for lack of required skill sets and risk management framework. This domain leadership gave NBFCs a free hand in pricing the loans.

The pandemic turned the table upside down. With NBFCs caught neck-deep in asset quality issues, banks hit them where it would hurt the most, taking advantage of the low-interest rate regime. Car loans were available at 7 per cent, home loans at 6.75 per cent, gold loans at sub-10 per cent and so on. NBFCs, including leaders such as HDFC, LIC Housing Finance, Shriram Group and Tata Capital, took time to fight competition. But the damage was already done.

Barring housing finance, where NBFCs have managed to hold their market share primarily due to the greater flexibility in paperwork and higher loan to value they offer, in pockets such as SME lending, auto loans, gold loans or even microfinance loans, holding the forte wasn’t possible.

A BCG report indicates that banks gained by 300-400 basis points (bps) market share in segments such as gold loans and microfinance. In SME lending, including LAP, India Ratings and Research observes higher balance transfers of better borrowers from NBFCs to banks, thus leading to a tilt in market shares. With NBFCs pricing the loans at 11.5-15 per cent and banks at 7-9 per cent, the rating firm expects the risk of balance transfer to persist in FY23.

The system may grow at 8 per cent year-on-year in FY22 and 14 per cent in FY23, accordingly to India Ratings. While FY23 may be incrementally better, the larger takeaway is that NBFCs are unlikely to replicate their past growth rates of 25-30 per cent.

There are three critical factors that could keep NBFCs on their toes.

Interest rate movement

Is India expected to see prolonged period of low interest rate regime? Answers will emerge in the upcoming RBI monetary policy. But a rate hike is expected to be gradual and calibrated. Therefore, interest costs for borrowers are unlikely to increase hurriedly. This means that competition from banks in terms of pricing may not fade either, leaving NBFCs with a limited bandwidth to price risk.

But what if the rate hike happens, given its possibility in the later part of 2022? As NBFCs depend on banks for nearly 70 per cent of their liquidity needs, including non-convertible debentures, they may not have the bandwidth to efficiently factor for a potential increase in cost of funds under the current environment.

Asset quality

From 4.5 per cent gross non-performing assets in FY20, India Ratings has pegged that the total stress (restructured loans and credit guarantee backed loans) for the sector increased almost threefold to 14.09 per cent in December 2021 quarter. With NBFCs set to be treated on par with banks on NPA reporting (daily reporting of the NPA status), the immediate focus will be to ensure that the existing pool of stressed assets don’t turn bad.

Unless it’s a high-quality borrower, NBFCs may be reluctant to dole out loans. But these borrowers are already moving to banks. Therefore, post the IL&FS crisis, NBFCs are once again faced with the dilemma of growth versus quality.

Advent of fintechs

If competition from banks isn’t enough, the emergence of fintechs and smaller NBFCs can be a more potent disruptor for the existing NBFCs. For example, players such as Aptus Housing and Home First are tiptoeing their larger peers in the affordable housing. Likewise, the convenience offered by fintechs has rendered the choice of lenders inconsequential for the borrower.

While the long-term survival of fintechs is being questioned by several experts, the point is once the damage is done NBFCs will find it tough to regain the lost territory.

The option of co-lending – banks and NBFCs jointly lending to a customer and sharing the risk – opened in 2020. But except certain smaller NBFCs joining hands with banks such as Ugro Capital and Bank of Baroda or IIFL Home Finance’s agreement with State Bank of India, the space is yet to see traction.

“Co-lending models are still evolving. Seamless technology interface and aligned credit philosophy are essentials for it to grow. In the absence of these, co-lending may not work,” says Pankaj Naik, Associate Director, India Ratings and Research. Therefore, while NBFCs who don’t have much capital may opt for co-lending, others may want to grow on their own.

The second probability is securitisation transactions or off-balance sheet loans. While this was an important source of augmenting liquidity for NBFCs, the pandemic slowed the pace of securitisation, as banks were reluctant to take the risk. Now, with the system better placed on asset quality, they could see a faster revival in securitisation deals in segments such as affordable housing and small ticket commercial vehicle loans.

The hub-and-spoke model, which played out till FY18, may once again gain prominence. But banks may be selective on traditional segments such as home loans, gold loans and big-ticket LAP, which have gravitated already towards them. Nicheness will, hence, be vital for NBFCs, going forward. If IL&FS crisis of 2018 taught the precious lesson of managing the asset-liability mismatch, the pandemic revealed the importance of granular asset composition.

As Naik sums up, NBFCs may not want to grow like they did in the past ahead of the pandemic. He expects them to grow their franchisee, being mindful of capital and liquidity buffers. In short, NBFCs have learnt the importance of value over volume, a call that old private sector banks such as Federal Bank and City Union Bank were forced to take many years ago.

Today, NBFCs are at the same juncture, having to choose between their inherent strengths and capital conservation. Given the competition and limited availability of investor interest, NBFCs may walk the same path – focussing on regional dominance, products which are core and grow within the bounds of their comfort.

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