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The 2020 Outlook for Indian NBFCs The future posits that NBFCs will continue to experience robust growth with minimal instances of delinquencies if the credit flow doesn't stop and the risk mitigation mechanisms improve.

By Piyush Khaitan

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Over the last decade, India's non-banking financial companies (NBFCs) have assumed critical importance in the financial system. The total asset size of all NBFCs in India is more than $370 billion and they provided close to 20 per cent of all credit in India till March 2018 versus 15 per cent three years ago. The importance of such a strong credit system in a growing economy like India can't be overemphasized.

The industry is growing from strength to strength by serving the underserved and often ignored retail and MSME segments which are the backbone of India's growth story. For instance, credit to MSMEs grew at a rate of 12 per cent year-on-year in June at a time when credit to larger firms was slowing down massively. NBFCs play a huge role in the growth of this sector as the lending book of NBFCs has grown at around 18 per cent annually over the last five years.

Liquidity Crunch

However, over the last year, the sector saw some hiccups in the form of a liquidity crunch when the failure of IL&FS unraveled. The failure of IL&FS to service its liabilities led to caution across the financial system about the strength of the sector. As funding became harder to come by, the total NBFC sanctions fell to INR 1.9 lakh crore this September compared to INR 2.9 lakh crore recorded in the same period last year, according to CRIF High Mark.

Because of the IL&FS incident, a temporary shock appeared in the NBFC circuit as banks tightened credit flows and liquidity squeeze reduced the pace of acceleration of credit as entities chose to focus on asset-liability management rather than just growing their books.

Additionally, mutual funds reduced NBFC exposure by 30 per cent in the last year and various leading entities in the sector moved over this challenge by increasing bank funding and managing external and internal borrowings through a tightrope. This enabled the funds to keep flowing to India's entrepreneurial MSMEs where even a temporary liquidity squeeze can halt business activities and hurt the topline as well as the bottom line.

It helped that the government took quick cognizance of the troubles in the sector and launched initiatives to provide relief. The Reserve Bank of India announced in August that banks can have an exposure of up to 20 per cent of their Tier 1 capital to a single NBFC as compared to the 15 per cent limit earlier. This helped boost credit flow as bank funding to NBFCs grew by 30 per cent year on year. At the same time, the regulator also eased the priority sector lending norms by allowing banks to provide funds to NBFCs for on-lending to agriculture up to INR 10 lakh, MSMEs up to INR 20 lakh and housing up to INR 20 lakh per borrower to be classified as priority sector lending.

New Risk Management Framework

However, another green shoot that emerged from the regulatory intervention as the RBI introduced a new liquidity risk management framework to holistically counter future risks in the sector.

Under the new framework, non-deposit taking NBFCs with asset size of more than INR 10,000 crore and all deposit taking NBFCs will have to maintain a liquidity coverage ratio (LCR) requirement of 50 per cent by December 1, 2020, and progressively increase it to 100 per cent by December 2024. Similarly, non-deposit taking NBFCs with asset size between INR 5,000 crore and INR 10,000 crore would be required to have a minimum LCR of 30 per cent by December 1, 2020.

This might have produced short-term pain in the industry but it's an excellent long-term measure to protect the sector from externalities and improve the overall risk management frameworks across the industry. This will not only boost the confidence in the robustness of the sector, but it could also potentially lower the cost of funds for NBFCs as their risk perception goes down massively due to the new LCR reporting framework.

Moreover, the RBI's emphasis on its commitment to not let any NBFC fail came as a strong signal from the government that it firmly stands behind the sector. Due to the easier liquidity provisions, the flow of funds to NBFCs from banks improved by over 30 per cent in just a year.

As a result, the sector now stands on a firm footing with the right regulatory provisions in place along with liquidity windows which have allowed NBFCs to raise funds. Overall, the signs are encouraging as the asset quality for SME lending remains stable and lower than commercial lending non-performing asset rates in India.

According to CIBIL, SME 1 segment had just 9 per cent delinquencies compared to NPAs reaching up to 14 per cent in the larger ticket size segment. Meanwhile, NBFCs looked outwards for funds to keep the credit cycles running. Many players have raised funds outside the country and these offshore borrowings are expected to continue going into 2020, at least till the time credit flow in the Indian economy resumes.

The crucial bit to note here is that lending by NBFCs forms the backbone of India's economy, especially for the micro, small and medium enterprises sector.

There are around 55-60 million MSME's in India, contributing to about 30 per cent of India's GDP. This sector had a credit demand of about INR 45 lakh crore in 2018 out of which 40 per cent was served by informal credit. As a result, there's a big opportunity in the coming years for NBFCs to capture this unserved population and partner in India's growth story. This is because banks often find it expensive or unviable to serve these segments which new-age NBFCs are serving on the back of advanced technology and better reach in the remote corners of the country.

The future posits that NBFCs will continue to experience robust growth with minimal instances of delinquencies if the credit flow doesn't stop and the risk mitigation mechanisms improve. As a whole, this calls for wider adoption of technology and adopting unorthodox lending strategies to find the niche of product-market fit. For instance, some of the new-age digital lenders supply credit to small businesses using point-of-sale terminal data as a proxy for the cashflows and the loans are disbursed through an electronic engine which makes the process safer as well as faster. Using such unique models, the firms are able to navigate the turbulent environment successfully.

The year 2020 calls for a reinvention of the NBFC business model as a whole because the continued churn from the past few quarters now must give way to improved business processes, better underwriting and a long-term approach at sustainable benign credit cycle than a reckless boost of loan books.

Piyush Khaitan

Founder & Managing Director, NeoGrowth Credit Pvt. Ltd

Piyush Khaitan (PK) is a seasoned operating executive who has successfully founded a number of businesses and operated them to high levels of success. He has over 30 years of experience in the Payments & Fintech industry focusing on Business Leadership, Payment Processing, SME Lending, Corporate Development, Business Operations, Technology and Strategy.

He is the Founder & Managing Director of NeoGrowth Credit Pvt. Ltd, a fintech company that provides unsecured loans to Small Business repaid by card receivables, e-commerce sales and other non-cash payments.

Before NeoGrowth, PK had founded and served as the Managing Director of Venture Infotek, which was India’s largest Payment Processing Company. Venture Infotek was divested to an MNC in 2010 in a landmark transaction.
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