Question

Until the IL&FS crisis, NBFCs had proved to be a strong base for the provision of credit for industry in India. In light of this statement, Discuss the role of NBFCs in India.

Answer 1

Approach:

• Define NBFC.
• Highlight the significance of NBFCs in Indian economy.
• Also highlight the various issues involved.
• Conclude by providing some suggestion in short.

NBFCs
A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property. A non-banking institution which is a company and has principal business of receiving deposits under any scheme or arrangement in one lump sum or in instalments by way of contributions or in any other manner is also a non-banking financial company (Residuary Non-banking Company).

Role of NBFCs in India
NBFCs are known as India’s shadow banking sector, a big source of credit to the country’s small and medium enterprises, realtors, homebuyers and consumers. NBFCs (Non Banking Financial Companies) play an important role in promoting inclusive growth in the country, by catering to the diverse financial needs of bank excluded customers.

1. Greater Employment Opportunities and Standard of Living
NBFCs help in creating more jobs in the country by promoting SMEs and private industries through lending them loans. This increase in new businesses consequently raises the demand for manpower and creates employment. Furthermore, the Purchasing Power Parity (PPP) of people rises and so does their standard of living. Retail and MSME segments have been key growth areas for NBFCs, with total credit outstanding of INR 7.5 trillion as on FY18.

2. Strengthening of Financial Market
The financial market relies heavily on Non-banking financial institutions for raising capital. The start-ups and small-sized businesses are dependent on funds offered by NBFCs and also in order to maintain liquidity. For effective functioning and balance in the financial market, NBFCs play a significant role.

3. Supplying long-term credits
Unlike the regular banks, NBFCs extend long-term credits to infrastructure, commerce and trade companies. They also allow industries to participate in equity. NBFCs have seen a significant increase in their share of total new disbursals at the cost of public sector banks. This is witnessed in the form of their share in the total credit market going up from 13% in 2015 to 16% in 2017.

4. Mobilisation of Funds
Non-banking financial companies help in rotation of resources, asset distribution and regulation of income to shape the economic development. They enable converting saving into investments and thus helps in the mobilisation of funds/resources in the economy.

5. Growth of National Income
As NBFCs aim to build capital for several industries – private and otherwise – they aid in accumulating a capital stock for the country. This directly adds on to the national income and results in the progression of Gross Domestic Product (GDP).

However, despite making rapid progress and capturing market share from commercial banks, their growing size and interconnectedness also raise concerns on financial stability especially after the IL&FS crisis. The emergence of new-age digital lenders has further intensified the competition for NBFCs in the market. There are various issues involved with the NBFCs, the key issue being taking up of significant credit risk and lack of effective monitoring and management of portfolio performance.

• Gaps in the underwriting model: The decline in asset quality for select NBFCs has stemmed from cases where underwriters are inexperienced, or with limited understanding of the local situation and dynamics that drive the demand for credit.
• Misalignment in product offerings with customer needs: Small NBFCs, in an effort to capture share, have expanded into new geographic locations and diversified their product portfolio. This has resulted in aggressive investment, increased cost of acquisition and operations.
• Asset-liability mismatch: Several NBFCs recently faced with a liquidity crunch, liabilities maturing and coming up for payment faster than loans in the same tenure. With dynamic short-term rates, such lenders risk resorting to the increased cost of funds to meet the shortfall, denting profitability. Additionally, this has also made it difficult for these NBFCs to raise capital for expansion in the market.

The default of a systemically important NBFC, has thrust corporate governance for the sector into the spotlight. The Government and regulators should take major steps to improve accountability and liquidity of the NBFC sector as the role of NBFCs is critical and their presence in a country would only boost the economy in the right direction.