Non-Banking Financial Companies Role in India's Development: A Way Forward [1st ed.] 978-981-13-3374-3;978-981-13-3375-0

Table of contents :
Front Matter ....Pages i-xxii
Status and Role of NBFCs (R. Kannan, K. R. Shanmugam, Saumitra Bhaduri)....Pages 1-7
Growth and Development of NBFCs (R. Kannan, K. R. Shanmugam, Saumitra Bhaduri)....Pages 9-36
Regulatory Developments and Prudential Norms (R. Kannan, K. R. Shanmugam, Saumitra Bhaduri)....Pages 37-60
Acceptability of NBFCs to the Public (R. Kannan, K. R. Shanmugam, Saumitra Bhaduri)....Pages 61-66
Demand for NBFCs’ Credit (R. Kannan, K. R. Shanmugam, Saumitra Bhaduri)....Pages 67-72
Risk Management in NBFCs (R. Kannan, K. R. Shanmugam, Saumitra Bhaduri)....Pages 73-80
Financial Inclusion and NBFCs (R. Kannan, K. R. Shanmugam, Saumitra Bhaduri)....Pages 81-94
Banks and NBFCs in India: A Comparative Analysis (R. Kannan, K. R. Shanmugam, Saumitra Bhaduri)....Pages 95-101
Non-banking Financial Intermediaries: International Experiences (R. Kannan, K. R. Shanmugam, Saumitra Bhaduri)....Pages 103-124
Conclusions and Recommendations (R. Kannan, K. R. Shanmugam, Saumitra Bhaduri)....Pages 125-138
Back Matter ....Pages 139-142

Citation preview

India Studies in Business and Economics

R. Kannan K. R. Shanmugam Saumitra Bhaduri

Non-Banking Financial Companies Role in India’s Development A Way Forward

India Studies in Business and Economics

The Indian economy is considered to be one of the fastest growing economies of the world with India amongst the most important G-20 economies. Ever since the Indian economy made its presence felt on the global platform, the research community is now even more interested in studying and analyzing what India has to offer. This series aims to bring forth the latest studies and research about India from the areas of economics, business, and management science. The titles featured in this series will present rigorous empirical research, often accompanied by policy recommendations, evoke and evaluate various aspects of the economy and the business and management landscape in India, with a special focus on India’s relationship with the world in terms of business and trade.

More information about this series at http://www.springer.com/series/11234

R. Kannan K. R. Shanmugam Saumitra Bhaduri •

•

Non-Banking Financial Companies Role in India’s Development A Way Forward

123

R. Kannan Madras School of Economics Chennai, Tamil Nadu, India

K. R. Shanmugam Madras School of Economics Chennai, Tamil Nadu, India

Saumitra Bhaduri Madras School of Economics Chennai, Tamil Nadu, India

ISSN 2198-0012 ISSN 2198-0020 (electronic) India Studies in Business and Economics ISBN 978-981-13-3374-3 ISBN 978-981-13-3375-0 (eBook) https://doi.org/10.1007/978-981-13-3375-0 © Springer Nature Singapore Pte Ltd. 2019 This work is subject to copyright. All rights are reserved by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Springer imprint is published by the registered company Springer Nature Singapore Pte Ltd. The registered company address is: 152 Beach Road, #21-01/04 Gateway East, Singapore 189721, Singapore

Foreword

Non-banking financial companies (NBFCs) have played an important role in India’s economic development. They offer a wide range of services to people at competitive prices, and these services are diversified in nature. NBFCs also play a key role in financial inclusion by complementing the banking sector in extending credit to neglected sectors, especially to MSMEs. In fact, commercial banks have copied many types of financial services offered by the NBFC sector. NBFCs in India have grown considerably in size, form and types of market products and instruments. While the banking sector has always been highly regulated, NBFCs have come under strict regulatory oversight only in recent decades. Due to various regulations prescribed by RBI, their health parameters have improved. In this process, they also contribute significantly to the financial stability of India. A balanced and sound financial sector is a basic requirement in reducing contagion. Compared to the banking sector, there have been fewer studies on the growth and contributions of NBFCs in India. The current book is no doubt a good addition to the literature in this area. At one place, the reader gets the details about all the balance sheet items, which clearly indicate the strengths and weakness. This book also discusses various committees appointed by RBI and Government of India in strengthening this sector. Risk management in NBFCs, infrastructure finance and financial inclusion are some areas dealt with in this book. In addition, the authors have analysed the development of NBFCs abroad and brought out the lessons for India. There have been several striking NBFC failures in the last three decades. The microfinance institutions also went through a difficult period largely because of the

v

vi

Foreword

faulty policies pursued by them. A book dealing with all aspects of NBFCs is very much the need of the hour. I am sure that this book will be found useful by students of finance and economics, bankers, officials from NBFCs and the regulators.

Chennai, India

Dr. C. Rangarajan Chairman, Madras School of Economics Former Chairman Economic Advisory Council to the Prime Minister Former Governor, Reserve Bank of India

Acknowledgements

This book is an outcome of the research study funded by the Financial Companies’ Research and Development Foundation (FCRDF). We have considerably benefited from discussions with Dr. C. Rangarajan, Chairman of Madras School of Economics, and with Mr. G. V. Raman, Mr. T. T. Srinivasaraghavan, Mr. K. M. Dugar and Mr. P. S. Balasubramaniam, who are Trustees of FCRDF. We have also considerably benefitted from discussions with Mr. Vijay Chordia, Managing Trustee, and other members of FCRDF, namely Mr. S. Bapu, Mr. P. Viswanathan and Mr. T. B. Kapali. We are thankful to all of them. Dr. A. Balasubramanian, Ms. Anshuma Chandok and Ms. Jothi of Madras School of Economics provided us with research assistance in compiling the data and preparation of the manuscript. We thank them for their sincere efforts. R. Kannan K. R. Shanmugam Saumitra Bhaduri

vii

Executive Summary

Non-banking financial companies (NBFCs) have been a wellspring of innovation since the Reserve Bank of India (RBI) formally recognised the segment in 1964, when ‘financial inclusion’ was not yet a buzzword. Over the years, NBFCs have grown faster and their contributions, in terms of assets to gross domestic product (GDP) ratio, have risen significantly to 13%. Their loans and advances have also increased materially, notwithstanding some ups and downs. Indeed, their bad loans are lower than those of banks, indicating these players have managed asset quality better. The NBFC sector remains work in progress, shaped by global winds, domestic vicissitudes and waves of regulatory changes. Traditionally, NBFCs have been dependent on banks for funds. But that changed after the global financial crisis in fiscal 2009, when they began to tap the capital market. Today, most of the larger ones meet over 50% of their fund requirement through market borrowings since it is cheaper. Concomitantly, the RBI regulations have closed the fault lines and tightened rules. RBI, in its latest regulations on the sector issued in fiscal 2015, set `5 billion as the dividing line. All NBFCs above this threshold are subject to capital to risk-weighted assets ratio (CRAR), prudential and income recognition norms. Those below this mark have fewer restrictions and could go in for mergers/ acquisitions. Consequently, the number of registered deposit taking NBFCs with RBI has come down from 428 in fiscal 2000 to 178 in fiscal 2017, though persistent efforts to raise customer confidence have shored up public deposits with these players to `0.43 trillion from `0.19 trillion. There are also the issues with shadow banks, or non-banking financial intermediaries, or NBFIs, operating outside the banking system. There are conflicting views on whether NBFCs in India should be treated as shadow banks, with implications for risk and regulation. Thus, achieving the right amount regulation and safeguards without unduly stifling the NBFC sector—which clearly serves an important purpose in the financial ecosystem—has been a challenge for policymakers and the central bank.

ix

x

Executive Summary

Two recent initiatives mooted by RBI stand out as significant in this process. The Working Group on Issues and Concerns in the NBFC sector, chaired by former RBI Deputy Governor Usha Thorat, and the Committee on Comprehensive Financial Services for Small Businesses and Low Income Households, chaired by Nachiket Mor, Member, Central Board of RBI, came up with specific recommendations that have been taken on board by RBI in its evolving regulatory framework. This book has the following objectives: • To study the role of NBFCs—in both formal and informal sectors—in furthering financial inclusion and last mile delivery of credit and their contribution to financial sector growth. • To analyse the acceptability of NBFCs to banks and other lenders compared with commercial borrowers and see whether there is a negative perception. • To assess the funding opportunities and challenges of NBFCs and find out whether there is a refinancing window such as the National Housing Bank for housing finance companies. • To review the present regulatory environment and check whether NBFCs are over-regulated. • To analyse the implications of recommendations of Usha Thorat Committee. • To review the NBFC models in other countries and highlight the lessons from them. • To provide suggestions and recommendations—both statutory and non-statutory —for the healthy growth and development of NBFCs in India. The study draws extensively on secondary data from published sources such as Trend and Progress in Banking reports of RBI, and the Financial Stability Board’s Global Shadow Banking reports, and research studies and speeches of executives of RBI. It keeps in mind that the sector has reached a critical mass and so the regulatory map needs to be redrawn with cautious optimism, obviating overconfidence and placing various segments in proper perspective. Several suggestions emerge from the study, and they are as follows: 1. Need to create a facility on the lines of the National Agricultural Credit Fund or Rural Infrastructure Development Fund for providing finance to select NBFCs that cater to unbanked regions and people. 2. Ease asset securitization norms for sectors supporting production, such as transport and infrastructure, to which NBFCs lend, and lower capital requirements and provisioning norms, bringing them on a par with those applicable to similarly placed financial institutions. 3. Need to classify credit given by banks to NBFCs as priority sector lending, given the important role played by NBFCs in financial inclusion. A special window can also be created through which banks could lend to NBFCs that, in turn, lend to priority sectors. To ensure transparency, external auditors could certify the money lent to the priority sector by NBFCs and heavy penalties could be prescribed for those misusing the facility.

Executive Summary

xi

4. Permit a select group of NBFCs (over and above infrastructure finance companies) to avail of external commercial borrowings, subject to a limit till enough experience is gained and strict rules. This will reduce the cost of funds for NBFCs and their dependence on domestic funds. 5. Need to streamline the classification of NBFCs. Classification based on deposit taking capacity is well recognised and could continue, but activity-based classification needs a rethink. 6. To create a level playing field with banks, extend benefits to NBFCs, but not indiscriminately. A graded set of benefits based on assets under management (AUM) or a set of health parameters such as CRAR, non-performing asset (NPA) ratio, expense ratio, yield on investment and strength of balance sheet would be a good incentive for NBFCs to adopt best risk management principles. 7. Work out, in consultation with the Ministry of Finance, the minimum threshold limit of AUM for supervision as many small-sized NBFCs do not pose contagion risk and the regulatory cost of supervising them outweighs benefits. NBFCs falling below that threshold could be supervised by a separate designated agency.

Contents

1

Status and Role of NBFCs . . . . . . . . . . . . . . . . . . . 1.1 Non-banking Financial Institutions in India . . . 1.2 Legal Definition of NBFC . . . . . . . . . . . . . . . . 1.3 Classification of NBFCs . . . . . . . . . . . . . . . . . 1.4 Status of NBFCs Vis-à-Vis Banks . . . . . . . . . . 1.5 Growth Constraints of NBFCs . . . . . . . . . . . . . 1.6 Shadow Banking and Regulatory Environment . 1.7 Aims of This Book . . . . . . . . . . . . . . . . . . . . .

. . . . . . . .

. . . . . . . .

. . . . . . . .

. . . . . . . .

. . . . . . . .

. . . . . . . .

. . . . . . . .

. . . . . . . .

. . . . . . . .

. . . . . . . .

. . . . . . . .

. . . . . . . .

1 1 2 2 3 4 5 6

2

Growth and Development of NBFCs . . . . . . . . . . . 2.1 Size and Ownership Pattern of NBFCs Sector 2.2 Financial Performance of NBFCs . . . . . . . . . . 2.3 Balance Sheet of NBFCs-D . . . . . . . . . . . . . . 2.4 Balance Sheet of NBFCs-ND-SI . . . . . . . . . . 2.5 Summing Up . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . .

. . . . . .

. . . . . .

. . . . . .

. . . . . .

. . . . . .

. . . . . .

. . . . . .

. . . . . .

. . . . . .

. . . . . .

. . . . . .

9 9 11 22 35 36

3

Regulatory Developments and Prudential Norms . . . . . . . . 3.1 Need for Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 Tracing the NBFC Regulatory Path . . . . . . . . . . . . . . . 3.3 Shah Working Committee . . . . . . . . . . . . . . . . . . . . . . 3.4 Khanna Committee . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.5 Usha Thorat Working Group . . . . . . . . . . . . . . . . . . . . 3.6 Our Suggestions on the RBI Working Group Report . . . 3.7 Regulatory Guidelines of the RBI (10 November 2014) 3.8 NBFC-Account Aggregator . . . . . . . . . . . . . . . . . . . . . 3.9 Peer-to-Peer Lending . . . . . . . . . . . . . . . . . . . . . . . . . . 3.10 Summing Up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . .

. . . . . . . . . . . .

. . . . . . . . . . . .

. . . . . . . . . . . .

. . . . . . . . . . . .

. . . . . . . . . . . .

37 37 37 39 40 41 43 46 50 51 52 53

. . . . . .

xiii

xiv

Contents

4

Acceptability of NBFCs to the Public . . . . . . . . . . . . . . . . . 4.1 Retail Business Growth . . . . . . . . . . . . . . . . . . . . . . . . 4.2 Product Differentiation . . . . . . . . . . . . . . . . . . . . . . . . 4.3 Procedural Convenience . . . . . . . . . . . . . . . . . . . . . . . 4.4 Effect on Borrowing Capacity . . . . . . . . . . . . . . . . . . . 4.5 Diluting Obsolescence Risk . . . . . . . . . . . . . . . . . . . . . 4.6 Time Tested and Borrower Friendly Appraisal Methods 4.7 Summing Up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . .

. . . . . . . .

. . . . . . . .

. . . . . . . .

. . . . . . . .

. . . . . . . .

61 62 62 63 64 64 65 65

5

Demand for NBFCs’ Credit . . . . . . . . . . . . . . . . . . . . . . . . . 5.1 Contribution of NBFCs in Meeting Credit Requirements . 5.2 Credit Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.3 Alternative Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.4 Summing Up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . .

. . . . .

. . . . .

. . . . .

. . . . .

67 67 68 70 72

6

Risk 6.1 6.2 6.3 6.4 6.5 6.6

. . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

73 73 74 77 77 78 80

7

Financial Inclusion and NBFCs . . . . . . . . . . . . . . . . . . . . . . . 7.1 Importance of Financial Inclusion . . . . . . . . . . . . . . . . . 7.2 An Overview of Financial Inclusion in India . . . . . . . . . 7.3 Evolution and Progress of Financial Inclusion in India . . 7.4 Micro, Small and Medium Enterprises (MSME) in India . 7.5 Summing Up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . .

. . . . . .

. . . . . .

. . . . . .

. . . . . .

81 81 83 84 90 93

8

Banks and NBFCs in India: A Comparative Analysis . . 8.1 Asset Growths of NBFCs and Banks . . . . . . . . . . . 8.2 NBFCs Share of Deposits . . . . . . . . . . . . . . . . . . . 8.3 Credit Growth: Banks Versus NBFCs . . . . . . . . . . 8.4 Regional Coverage of NBFCs and Banking Sector . 8.5 Share in Retail Finance by NBFC’s and Banks . . . . 8.6 Infrastructure Financing by NBFCs Versus Banking 8.7 Profitability of NBFCs and Banks . . . . . . . . . . . . . 8.8 Risk Involvement of NBFCs-ND-SI in India . . . . . 8.9 Summing Up . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . .

. . . . . . Sector . ...... ...... ......

. . . . . . . . . .

. . . . . . . . . .

. 95 . 95 . 97 . 97 . 97 . 98 . 99 . 99 . 100 . 101

9

Non-banking Financial Intermediaries: International Experiences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103 9.1 Non-banking Financial Intermediaries . . . . . . . . . . . . . . . . . . . 103 9.2 An Overview of Financial Systems of 28 Major Countries . . . . 105

Management in NBFCs . . . . . . . . . . . . . . . . . . Risk Management . . . . . . . . . . . . . . . . . . . . . . Risk Profile of NBFCs . . . . . . . . . . . . . . . . . . Economic Capital . . . . . . . . . . . . . . . . . . . . . . Interconnectedness Between Banks and NBFCs Prudential Parameters . . . . . . . . . . . . . . . . . . . Summing Up . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

. . . . . .

. . . . . . .

. . . . . .

. . . . . . .

. . . . . .

. . . . . .

Contents

9.3 9.4 9.5 9.6 9.7 9.8

xv

Development and Growth of NBFIs Across Jurisdictions Interconnectedness Between Banks and NBFIs . . . . . . . . Size of Insurance and Pension Funds: A Note . . . . . . . . Relationship Between Development of NBFIs, Banks and Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Regulatory Regime for NBFIs Across Nations . . . . . . . . Summing Up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

10 Conclusions and Recommendations . . . . . . 10.1 Where NBFCs Stand Today . . . . . . . 10.2 Mooting a Roadmap for NBFCs . . . . 10.3 Assessing NBFCs’ Strengths . . . . . . . 10.4 Examining the Regulatory Regime for 10.5 An Update . . . . . . . . . . . . . . . . . . . . 10.6 Summing Up . . . . . . . . . . . . . . . . . .

. . . .

. . . .

. . . .

. . . .

. . . .

. . . .

. . . . NBFCs . ....... .......

. . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

. . . . . 109 . . . . . 111 . . . . . 115 . . . . . 118 . . . . . 118 . . . . . 123 . . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

. . . . . . .

125 125 128 128 129 136 137

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139

About the Authors

R. Kannan is an Honorary Professor of Madras School of Economics. He retired as Principal Advisor at the Reserve Bank of India after 30 years of service. While at the RBI, he was deputed to the IMF as an advisor (1996-2001) and was also an advisor to the Governor of the Bank of Mauritius (1994-96). He was member of the Insurance Regulatory and Development Authority, and was closely involved in writing the BASEL III regulations of selected Asian economies. He has published about 50 papers in various journals encompassing monetary policy, fiscal policy, balance of payments, exchange rate, pensions, economic capital for the life insurance industry, and early warning systems for the life insurance industry. He is currently teaching at the MSE on risk measurement and management, central banking, financial regulations and banking supervision. K. R. Shanmugam is a Professor and the Director of Madras School of Economics, specialising in applied economics, public finance, finance and banking. He is also a non-official independent director of ITI limited, a member of the Steering Committee on Research in Environment at the MoEFCC, and member of the Academic Council of the Central University of Tamil Nadu. He has published about 40 research articles in various journals and edited volumes, and has edited five books. Saumitra Bhaduri received his Master’s degree in Econometrics from Calcutta University, Kolkata, India, and his PhD in Financial Economics from Indira Gandhi Institute of Development Research (IGIDR), Mumbai, India. He currently works as a Professor at Madras School of Economics, Chennai, India, where he regularly offers courses on financial economics and econometrics, and on advanced quantitative techniques. He previously worked at GE Capital, the financial services division of the General Electric Company, and has held various quantitative analysis positions in the company’s finance services. He also founded and headed the

xvii

xviii

About the Authors

GE – MSE Decision Sciences Laboratory, where he was responsible for developing state-of-the-art research output for GE. He has also published several research articles in various international journals. His research interests include financial economics and econometrics, quantitative techniques and advanced analytics.

List of Tables

Table Table Table Table

2.1 2.2 2.3 2.4

Table 2.5 Table 2.6 Table 2.7 Table 2.8 Table 2.9 Table 2.10 Table 2.11 Table 2.12 Table 2.13 Table 2.14 Table 2.15 Table 2.16 Table 3.1 Table 3.2 Table 4.1 Table 4.2

Number of NBFCs and size of banks and NBFCs in India . Ownership pattern of NBFCs in India . . . . . . . . . . . . . . . . . Annual growth of asset of NBFC (%) . . . . . . . . . . . . . . . . . Herfindahl–Hirschman index: business concentration analysis for NBFCs and banks . . . . . . . . . . . . . . . . . . . . . . . Classification of assets of NBFCs-D by category of NBFCs: asset finance companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital adequacy ratio of NBFCs-ND-SI—by type of NBFC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Financial performances of NBFCs-D and NBFCs-ND-SI (` billion) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Financial performances of RNBC (` billion) . . . . . . . . . . . . Assets and liabilities of NBFCs-D (Consolidated balance sheet in ` billion) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Major components of liabilities of NBFCs-D by classification of NBFCs (% share in total) . . . . . . . . . . . . . . Debt-to-asset ratio and debt–equity ratio (NBFCs-D) . . . . . . Public deposits held by NBFCs-D by deposit ranges . . . . . . Public deposits held by NBFCs-D: interest rate range-wise (Amount in ` crore) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Percentage distribution of the maturity pattern of public deposits held by NBFCs-D (Amount in ` crore) . . . . . . . . . Sources of borrowings by NBFCs-D (` billion) . . . . . . . . . . Assets and liabilities of NBFCs-ND-SI (Consolidated balance sheet). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Key changes in the NBFCs regulations (2014–16) . . . . . . . . Chronological account of regulatory developments in the NBFC sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Percentage share in retail finance . . . . . . . . . . . . . . . . . . . . . Market shares of NBFCs (in %). . . . . . . . . . . . . . . . . . . . . .

.. .. ..

9 10 12

..

17

..

20

..

20

.. ..

21 22

..

23

.. .. ..

26 29 30

..

32

.. ..

33 34

.. ..

35 48

.. .. ..

56 63 63

xix

xx

List of Tables

Table 5.1 Table 5.2 Table 6.1 Table 6.2 Table 6.3 Table 6.4 Table 7.1 Table 7.2 Table 7.3 Table 7.4

Table 9.1 Table 9.2 Table 9.3 Table Table Table Table Table Table

9.4 9.5 9.6 9.7 9.8 9.9

Share of public deposits, bank borrowings and loans and advances of NBFCs-D (in %) . . . . . . . . . . . . . . . . . . . . Growth of total assets of banks and NBFCs . . . . . . . . . . . . Weighted mean of deposits of NBFCs-D . . . . . . . . . . . . . . . Percentage distributions of assets and liabilities over various time buckets . . . . . . . . . . . . . . . . . . . . . . . . . . CRAR of NBFCs-D and commercial banks . . . . . . . . . . . . . Non-performing assets of banks and NBFCs . . . . . . . . . . . . World bank’s Findex-select indicators on financial inclusion (2017) (Proportion of population of age 15+) . . . . . . . . . . . Progress of financial inclusion plan . . . . . . . . . . . . . . . . . . . Financial inclusion index of top 10 countries . . . . . . . . . . . . Outstanding credit demand and supply of MSMEs—projected by planning commissions: (` crore) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Key economic and financial indicators of nations (2016) . . . Size of banks and non-banks (NBFIs) in 2016 . . . . . . . . . . Average annual growth of NBFIs assets and banks assets in % . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Composition of NBFIs (at end of 2016) . . . . . . . . . . . . . . . Interconnectedness between banks and NBFIs . . . . . . . . . . . Size of insurance companies and pension funds (2016) . . . . Size of shadow banks and their growth . . . . . . . . . . . . . . . . Correlation of NBFIs assets with other indicators . . . . . . . . Determinants of NBFIs/SBs assets of 26 major countries (in 2016) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

.. .. ..

68 69 76

.. .. ..

77 78 79

.. .. ..

84 87 89

.. 92 . . 107 . . 108 . . . . . .

. . . . . .

112 113 114 116 117 118

. . 119

List of Charts

Chart Chart Chart Chart

2.1 2.2 2.3 2.4

Chart 2.5 Chart Chart Chart Chart Chart

2.6 2.7 2.8 2.9 2.10

Chart 2.11 Chart Chart Chart Chart

2.12 2.13 2.14 3.1

Chart Chart Chart Chart

3.2 3.3 4.1 5.1

Chart 5.2 Chart 7.1 Chart 7.2

Trend in NBFCs’ assets (` billion) . . . . . . . . . . . . . . . . . . . . Trends in public deposits with NBFCs (` crore) . . . . . . . . . Growth of net owned funds of NBFCs (` billion) . . . . . . . . Composition of NBFCs advances (2014 and 2017). Source CRISIL research . . . . . . . . . . . . . . . . . . . . . . . . . . . . Trends in bank and market borrowings by the NBFCs in India (` billion) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Trends in bank borrowings (` billion) by NBFCs-D . . . . . . Proportion of NBFCs assets to bank assets (%) . . . . . . . . . . Credit growth in banks, NBFCs and housing finances (%) . . Net profit growth of NBFCs (` billion) . . . . . . . . . . . . . . . . Net profit–income ratio: NBFC-D, NBFC-ND and RNBCs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Trends in return on assets: NBFCs-D, NBFCs-ND and RNBCs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Trends in return on assets: NBFCs, banks and NHBs . . . . . Non-performing asset growth of NBFCs . . . . . . . . . . . . . . . Type of investments (NBFCs-D): 2011–12 and 2016–17 . . . Chronological detail of key regulatory changes for NBFCs. Source PwC (2016) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . New asset classification norms . . . . . . . . . . . . . . . . . . . . . . . Revised NBFCs classification . . . . . . . . . . . . . . . . . . . . . . . . NBFCs retail AUM (in trillion Indian rupees) . . . . . . . . . . . Growth of online consumer lending in India. Source Tracxn Alternative Lending Landscape, India—July 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Growth of online consumer lending in India. Source PwC (2016) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Correlation between inequality in the use of formal accounts and inequality in income . . . . . . . . . . . . . . . . . . . . Account penetration in India by individual characteristics . .

.. .. ..

11 12 13

..

14

. . . . .

. . . . .

14 15 15 16 17

..

18

. . . .

. . . .

18 18 19 25

. . . .

. . . .

39 46 48 66

..

71

..

71

.. ..

82 82 xxi

xxii

List of Charts

Chart 7.3

Chart 7.4

Chart 7.5

Chart 7.6 Chart 8.1 Chart 8.2 Chart 8.3 Chart 8.4 Chart 8.5 Chart Chart Chart Chart Chart Chart Chart

8.6 8.7 8.8 8.9 9.1 9.2 9.3

Financial demand flow chart for MSME sector in India. Source IFC (2012) (MSME Finance in India A Research Study) p. 14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Formal source of credit to MSME (Formal and NBFCs). Source RBI, SIDBI, Sa-Dhan, Annual Reports of NBFC’s, Primary Research; IFC-Intellecap Analysis . . . . . . . . . . . . . . Demands and supply financial gaps of MSME sector. Source RBI, SIDBI, Sa-Dhan, Annual Report of NBFCs, Primary Research; IFC-Intellecap Analysis . . . . . . . . . . . . . . Challenges faced by banking sector in financing MSME sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Asset growth of NBFCs and banks in India . . . . . . . . . . . . . Proportion of NBFCs assets to bank assets (%) . . . . . . . . . . NBFC’s share of deposits in the financial savings of households . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Credit growth in banks and NBFCs (%). . . . . . . . . . . . . . . . Rural and urban coverage of NBFCs and banking sector. Source CRISIL (2011) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Share in retail finance NBFCs vis-a-vis banks . . . . . . . . . . . Lending to infrastructure sector NBFCs vis-a-vis banks . . . . Trends in return on assets: NBFCs and banks . . . . . . . . . . . NPA ratios of NBFCs-ND-SI and banks (%) . . . . . . . . . . . . Share of banks in the total financial system assets (2016) . . Share of NBFIs in the total financial system assets (2016) . . Country’s share (%) in total NBFIs assets in 28 nations (2016). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

..

90

..

91

..

91

.. .. ..

93 96 96

.. ..

97 98

. . . . . . .

98 99 99 100 100 109 110

. . . . . . .

. . 110

Chapter 1

Status and Role of NBFCs

1.1 Non-banking Financial Institutions in India Traditionally, India has a bank-dominated financial sector. However, the non-bank financial institutions or intermediaries (NBFIs) have also coexisted. The NBFIs consist of varieties of financial institutions that cater to a wide range of financial requirements. They can be grouped into: (i) financial institutions (FIs) and (ii) non-banking financial companies (NBFCs).1 The FIs include Export-Import Bank of India (Exim), National Bank for Agriculture and Rural Development (NABARD), National Housing Board (NHB) and Small Industries Development Bank of India (SIDBI). They, in general, meet the credit requirement of long-term developmental needs. The NBFCs are mostly private sector institutions. Their presence could be dated back to the late 1940s when many small finance companies offered funding for the purchase of trucks, etc. Since then, this sector has recorded a phenomenal growth. Today, the NBFCs form an integral part of the Indian financial system. They perform a diversified range of functions and offer various services including personal loans, housing loans, gold loans, insurance and loans for purchasing motor vehicles, machinery and farm equipments to individuals, corporate and institutional clients. The NBFCs play a supplementary role by way of providing funding to those who could not be serviced by the banks and thus help support real economic activity. They also offer some of the services to the vulnerable section of the population. This is a healthy competition for banks. The NBFCs also play a vital role in financial inclusion by complementing the regular banks in reaching out credit to the unbanked segments of the society, especially to Micro, Small and Medium Enterprises (MSMEs). The success of NBFCs can be attributed to their better product lines with low costs, wider and effective

1 Since

early nineties, the primary dealers have also been included. The primary dealers play an important role in both primary and secondary government security markets. © Springer Nature Singapore Pte Ltd. 2019 R. Kannan et al., Non-Banking Financial Companies Role in India’s Development, India Studies in Business and Economics, https://doi.org/10.1007/978-981-13-3375-0_1

1

2

1 Status and Role of NBFCs

reach, better risk handling capabilities to check and control bad debts. The NBFCs efforts to get ground-level understanding of their customers’ profiles and their credit needs have given them an edge. They have better ability to innovate and customize their products as per their clients’ needs. These characteristics make them the perfect conduit for delivering credits to MSMEs. Their contributions to the development of Indian economy are well recognized in many committee reports, research studies and various reports brought out by the Reserve Bank of India (RBI), like the Second Narasimham Committee Report (1988), the RBI discussion paper (in January 1999) on “Harmonisation of the Role and Operations of DFIs and Banks” and also in the Report of Working Group on Money Supply (2000) with Dr. Y. V. Reddy as Chairman.

1.2 Legal Definition of NBFC In India, a company is considered as an NBFC if it is incorporated under the Companies Act (1956) and “carries on as its business or part of its business, any of the activities listed in Section 45 I(c) of the RBI Act (1934), viz. business of making loans/advances or acquisition of shares/securities, etc., or hire purchase finance or insurance business or chit fund activities or lending in any manner provided the principal business of such a company does not constitute any of the following nonfinancial activities, viz. (a) agricultural operations, (b) industrial activity, (c) trading in goods (other than securities), (d) providing services and (e) purchase, construction or sale of immovable property. Further in terms of Section 45 I (f) of the RBI Act, a company would also be a NBFC if its principal business is that of receiving deposits under any scheme or arrangement” (Vijaya Bhaskar 2014) or in any other manner or lending in any manner (these are known as Residuary Non-Banking Company).2 While it is mandatory that every NBFC should register with RBI, certain categories of NBFCs that are regulated by other regulators are exempted from the requirement.3

1.3 Classification of NBFCs The NBFCs in India are broadly grouped into various two categories based on their liability structure and activities. 2 The

RNBC has as its principal business the receiving deposits under any scheme or arrangement and not being investment, asset financing or loan company. It cannot accept deposits repayable on demand. 3 For instances, (i) venture capital fund/merchant banking companies/stock broking companies registered with SEBI; (ii) insurance company holding a valid Certificate of Registration from IRDA; (iii) nidhi companies as notified under Section 620 A of the Companies Act (1956); (iv) chit companies as defined in Clause (b) of Section 2 of the Chit Funds Act (1982); (v) housing finance companies regulated by National Housing Bank are exempted.

1.3 Classification of NBFCs

3

Based on Liability Structure On the macro-side, there are two categories of NBFCs, viz. those accepting public deposits (NBFCs-D) and those who do not (NBFCs-ND). The NBFCs-ND was subject to minimal regulation till 2007. However, from April 2007, systematically important non-deposit taking NBFCs were defined as those who belong to this category, as defined earlier, but with assets of |1 billion and above and prudential regulations are made applicable to them. Later, two international standards setting bodies, namely (i) the Basel Committee on Banking Supervision and (ii) the Financial Stability Board defined what a Systemically Important Financial Institution (SIFI) based on four major parameters: size, complexity, interconnectedness, and lack of readily available substitutes for the financial infrastructure it provides. As a result, the financial sector regulators in various jurisdictions refined SIFIs within their jurisdiction. Consequently, the threshold for systemic significance in India was revised as those who have assets of |5 billion (i.e. |500 crore) and more. Now, the NBFCs-ND-SIs are NBFCs-ND with assets of |5 billion and more. All NBFC-D and NBFCs-ND-SI are subjected to prudential regulations such as capital adequacy requirements and provisioning norms along with reporting requirements (RBI 2017). Based on the redefinition, now the NBFCs fall into two broad categories as: (i) Deposit accepting NBFCs (NBFCs-D). (ii) Non-deposit accepting NBFCs with asset size of less than |500 crore (NBFCsND) and (iii) Non-deposit accepting NBFCs with assets of |500 crore and above (NBFCsND-SI). Based on Activities Based on their activities, the NBFCs are categorized as: asset finance companies (AFC), investment companies (IC), investment loan companies (ILC), infrastructure finance companies (IFC), core investment companies (CIC), infrastructure debt fundnon-banking financial companies (IDF-NBFC), non-banking financial companymicro-finance institutions (NBFC-MFI), NBFC factors (Raj Kumar 2018) and systemically important core investment companies (CIC-ND-SI).4 In a broader sense, they also include stockbrokers, insurance companies, chit funds, leasing companies (Gandhi 2014).5

1.4 Status of NBFCs Vis-à-Vis Banks While the functions of NBFCs and that of banks look similar, they differ in the following certain important aspects: (i) from the monetary policy point of view, banks are the only institutions capable of creating credit; (ii) the scheme of Deposit 4 The

NBFCs are also engaged into distribution of financial products, acting as business correspondents to banks and facilitating remittances (Gandhi 2014). 5 They do not incorporate institutions with agricultural operation or industrial activity or sale purchase/construction of immovable property as principal business.

4

1 Status and Role of NBFCs

Insurance and Credit Guarantee Corporation (DICGC) of India does not have control over the NBFCs; (iii) NBFCs are not permitted to accept the demand deposits; (iv) NBFCs are not covered as a part of a Payment Settlement System of RBI6 ; and (v) NBFCs-D are not subject to Cash Reserve Ratio (CRR) requirements, but they have to maintain 15% of their public deposit liabilities in government and other approved securities as liquid assets. The NBFCs, in general, provide different forms of financial services to the society within the economic system. They serve as competitors to banks and specialize in sectors or groups. As a result, customers receive more efficient services. While banks avail of short-term funds for trade and commerce, NBFCs cater to medium- and longterm credit needs, often borrowing funds from banks and extending them as loans to their customers (Shanmugam 2015). Thus, NBFCs have emerged as a very important and significant segment, financing Small and Medium Enterprises (SMEs), second-hand vehicles and other productive sectors of the economy.7 They play a complementary role in the financial inclusion agenda of the government. They also bring in the much-needed diversity to the financial sector, diversifying or minimizing the risks, increasing the liquidity in the markets and promoting the financial stability. The NBFCs have an edge over banks in providing finance owing to their simplified sanction procedures, flexibility and timeliness in meeting credit needs, and low cost of operations. Thus, NBFCs in India have grown considerably in size, form and operations in a variety of market products and instruments. While the banking sector has always been highly regulated, NBFCs are facing many regulatory restrictions too, in recent years.

1.5 Growth Constraints of NBFCs A major issue remains funding. Till 1997, banks and financial institutions were lending to NBFCs. But with the implementation of the AC Shah Committee report (1992) recommendations, these institutions are no longer interested in funding them and instead offer hire purchase funding directly. The AC Shah Committee report, however, paved the way for reforms in the NBFC sector, bringing a lot of clarity and discipline among them in terms of prescribing provisioning norms, non-recognition of non-performing asset (NPA) income, capital adequacy, etc.

6 Reserve

Bank of India does not allow the NBFCs to enjoy the refinance facilities and to have cheque deposits. Thus, the NBFCs are not part of the payment and settlement systems. 7 The prominence of NBFCs in facilitating the transfer of funds from savers to borrowers is duly recognized because of the positive features witnessed in the economy, viz. lower transaction costs, decision-making ability, customers’ orientation and prompt services. For example, the growth of NBFCs laid the foundation for the development of the road transport sector because the NBFCs mainly provide finance for the purchase of transport vehicles. In addition, they offer finance to purchase other assets like generators, furniture, computers and consumer durables.

1.5 Growth Constraints of NBFCs

5

Further, although the NBFCs follow all prudential norms similar to banks, they are not treated on a par in tax matters. Faced with consecutive tax problems, their lending costs have risen significantly. As a result, most NBFCs are forced to switch to the hypothecation business from their mainstay hire purchase. Another issue is the spurt in cost of funds. Earlier, bank lending to NBFCs for transport sector credit was categorized as priority sector lending. This enabled NBFCs to access funds at lower interest rate. However, towards the end of the 1990s, when banks were permitted to take up hire purchase directly, their lending to NBFCs started declining. More recently, the RBI withdrew this provision, following which the cost of borrowing has risen for NBFCs.

1.6 Shadow Banking and Regulatory Environment While many use the terms NBFCs and NBFIs (non-banking financial institutions) interchangeably, there is a technical difference. The term NBFC is more suited to India as it includes companies registered under the Companies Act, 1956, and also under Section 45 I(a) of the RBI Act, 1934. In many other countries, NBFIs or shadow banks are financial intermediaries involved in credit intermediation outside the traditional banking system. The sub-sectors of the shadow banking sector include money market funds, financial companies, structured financial vehicles, hedge funds, equity funds, fixed income funds, broker–dealers, real estate investment funds/trusts and trust companies (FSB 2014).8 Shadow banking takes vastly different forms across countries, with NBFI assets representing 30% of the total global financial assets. According to FSB (2018), NBFI assets (in major 21 nations and the Euro area) amounted to $99 trillion in 2017. The USA had the largest NBFI assets of $27.1 trillion; the UK, $7.1 trillion; and China, $9.6 trillion. The size of shadow banking in India is estimated at about $429 billion (0.9% of the global shadow banking industry). The role of shadow banking as a source of systemic risk was an important learning outcome of the 2008 financial crisis, when the NBFC sector was under severe pressure due to the funding interlinkages between NBFCs and mutual funds.9 Experts in the field, various committees and advisory groups believe that too little or no regulation can also lead to crisis. These risks can be controlled only through proper regulation. However, too strict or inappropriate regulation can hinder innovation and development. Therefore, getting the right balance is a perpetual challenge for financial regulators and supervisors. 8 The

Regional Constitution Group of Asia of Financial Stability Board (FSB) in its Report on Shadow Banking in Asia (2014) adds the followings: public financial institutions, insurance companies and pension funds. 9 The ripple effects of the turmoil in the western economies led to liquidity issues and redemption pressures on mutual funds, which in turn led to funding issues for NBFCs as mutual funds were unable to roll over the corporate debt papers of NBFCs. Many had to downsize their balance sheets or enter into distress sale of their loan portfolios (Gandhi 2014).

6

1 Status and Role of NBFCs

There are two views on whether NBFCs in India can be treated as shadow banks or not. One view is that they are not, as these institutions are under the RBI’s regulation. Another view holds that they are, even if regulated. This is because: (i) most of them are lightly regulated, (ii) pockets within the sector are not subject to regulation and/or supervision, and (iii) they are allowed to conduct activities that may not fall under regulation (Gandhi 2014).10 There are also no restrictions on the number of NBFCs that a single group can set up and on the number of branches of NBFCs. Further, some of the NBFCs operate as conglomerates having business interests spilling over to insurance, broking, mutual funds and real estate. The interconnectedness of NBFCs with other financial intermediaries has increased with greater access to public funds through non-convertible debentures (NCDs), commercial papers (CPs), borrowing from banks, etc. In such case, NBFCs can be exposed to risks arising out of counterparty failures, funding and asset concentration, and interest rate movements. They can also expose to risks pertaining to liquidity and solvency. In turn, these risks of the NBFCs can easily be transmitted to the entire financial sector. To address this risk and arbitrage arising from differential regulations, without impeding the dynamism displayed by NBFCs in delivering innovation and last mile connectivity for meeting the credit needs of productive sectors of the economy, the RBI revised its regulatory framework for NBFCs in November 2014. It considered certain recommendations provided by the Working Group on Issues and Concerns in the NBFC Sector (chaired by Usha Thorat) and the Committee on Comprehensive Financial Services for Small Businesses and Low-Income Households (chaired by Nachiket Mor). The new regulatory framework may have a significant impact on the operating environment for NBFCs.

1.7 Aims of This Book Against this backdrop, this book aims to analyse (i) the role of NBFCs—both in formal and informal sectors—in furthering financial inclusion and last mile delivery of credit and their contribution to financial sector growth; (ii) the comparative acceptability of NBFCs to the lenders including banks, vis-à-vis the commercial borrowers and see whether there is a negative perception; (iii) the funding opportunities and challenges of NBFCs; (iv) the present regulatory developments and prudential norms related to the NBFCs; (v) the implications of recommendations of Usha Thorat Committee; and (vi) the NBFC models in other countries and highlight the lessons from them. Finally based on the analyses of the study, it provides suggestions and recommendations—both statutory and non-statutory for the healthy growth—and development of NBFCs in India—both large and small.

10 The principal business criteria for registration allow NBFCs the freedom to conduct other activities, beyond financial activities, from their balance sheets. While there are several large entities, undertaking financial business, they do not come within the definition of the NBFC (Gandhi 2014).

1.7 Aims of This Book

7

This study is primarily based on the secondary data that are available in published sources such as Trend and Progress Report of the RBI, and Financial Stability Board’s Global Shadow Banking Reports, and research studies and speeches of executives of the RBI. The remaining chapters of this book proceed as follows. Chapter 2 briefly explains the growth and development of NBFCs sector in India over the years and its performance. Chapter 3 reviews the regulatory development and prudential norms of NBFCs in India. While Chap. 4 presents a discussion on the acceptability of NBFCs by public, Chap. 5 deals with demand for NBFCs credit. Chapter 6 discusses the risk management in NBFCs, while Chap. 7 analyses the role of NBFCs in financial inclusion. Chapter 8 makes a comparative analysis on NBFCs and banks in India, while Chap. 9 aims to shed some light on the size and structure of non-banking financial intermediaries or shadow banks in various countries and regulatory regimes for them in the major global financial system. The final chapter provides policy suggestions and concluding remarks.

Chapter 2

Growth and Development of NBFCs

2.1 Size and Ownership Pattern of NBFCs Sector In 1999, 7855 NBFCs registered with the RBI. However, in 2002, the number of NBFCs registered with RBI increased to 14,077. During this period, however, the number of deposit taking NBFCs increased from 624 to 784 (not shown). In 2006, the number of NBFCs declined to 13,014 and the number of NBFCs-D to 428 (Table 2.1). After that, both continuously declined. As on March 2017, there were 11,571 NBFCs, of which 179 were NBFCs-D. There were 220 systemically important non-deposit accepting NBFCs (NBFCs-ND-SI).

Table 2.1 Number of NBFCs and size of banks and NBFCs in India Year

Number of NBFCs

Number of NBFCs-D

NBFCs assets as % of GDP

Banks assets as % of GDP

2006

13,014

428

8.4

75.4

2007

12,968

401

9.1

80.6

2008

12,809

364

10.1

86.8

2009

12,740

336

9.9

93.0

2010

12,630

311

10.5

93.0

2011

12,409

297

11.1

92.3

2012

12,385

273

12.1

95.2

2013

12,229

254

12.9

96.4

2014

12,029

241

12.6

97.7

2015

11,842

220

11.9

96.7

2016

11,682

199

12.6

96.0

2017

11,571

179

13.0

93.2

Source Reports on trend and progress of banking in India (various years) and CRISIL research © Springer Nature Singapore Pte Ltd. 2019 R. Kannan et al., Non-Banking Financial Companies Role in India’s Development, India Studies in Business and Economics, https://doi.org/10.1007/978-981-13-3375-0_2

9

10

2 Growth and Development of NBFCs

The reasons for the continued decline in the registered NBFCs and NBFCs-D are: (i) strict government regulations, (ii) cancellation of Certificates of Registration (CoR) and (iii) migration to non-deposit taking category. Thus, the NBFC segment has witnessed consolidation in the recent past, especially in the non-deposit-taking NBFCs with the RBI witnessing a consistent year-on-year decline. However, the NBFCs assets relative to GDP (at current market prices) increased steadily from 8.4% in 2006 to 13% in 2017. The banks’ assets as per cent of GDP increased from 75.4% in 2006 to 97.7% in 2014 and then declined to 93.2% in 2017, indicating the bank-dominated financial system in India (Table 2.1). The ownership patterns of NBFCs-D and NBFCs-ND-SI are shown in Table 2.2. During 2010–2017, while the number of non-government NBFCs-D declined from 302 to 123, their share in total NBFCs-D slightly increased from 97.1 to 98.4%. At the same time, the number of NBFCs-ND-NI also declined from 258 to 205 and their share in total NBFCs-ND-SI declined from 96.6 to 93.2%. However, these companies are still predominantly the non-government (public and private limited) companies. It is also noticed that the share of public limited companies in total NBFCs-ND-SI increased from 36.3% in 2010 to 47.7% in 2017 while their share in total NBFCs-D decreased marginally from 2.9 to 1.6%. At the same time, the share of private limited companies in NBFCs-ND-SI decreased continuously from 60.3 to 45.5%. Thus, we can witness a clear consolidation in the number of NBFCs. This falling trend may be partially due to regulatory changes and partially due to their balance sheet pressures.

Table 2.2 Ownership pattern of NBFCs in India Ownership

2010

2012

2014

2015

2016

2017P

NBFC- NBFC- NBFC- NBFC- NBFC- NBFC- NBFC- NBFC- NBFC- NBFC- NBFC- NBFCNDD NDD NDD NDD NDD NDD SI SI SI SI SI SI Government companies

9 (3.4)

9 (2.9)

9 (2.4)

7 (2.6)

15 (3.0)

5 (2.3)

15 (3.2)

5 (2.5)

15 (6.8)

5 (2.9)

15 (6.8)

2 (1.6)

Nongovernment companies of which

258 (96.6)

302 (97.1)

366 (97.6)

266 (97.4)

478 (97.0)

210 (97.7)

456 (96.8)

195 (97.5)

205 (93.2)

169 (97.1)

205 (93.2)

123 (98.4)

Public Ltd. companies

97 (36.3)

9 (2.9)

168 (44.8)

3 (1.1)

252 (51.1)

5 (2.3)

243 (51.6)

4 (2.0)

105 (47.7)

3 (1.7)

105 (47.7)

2 (1.6)

Private Ltd. companies

161 (60.3)

293 (94.2)

198 (52.8)

263 (96.3)

226 (45.8)

205 (95.3)

213 (45.2)

191 (95.5)

100 (45.5)

166 (95.4)

100 (45.5)

121 (96.8)

Total companies

267 311 375 273 493 (100.0) (100.0) (100.0) (100.0) (100)

215 (100)

471 (100)

200 (100)

220 (100)

174 (100)

220 (100)

125 (100)

Source Reports on trend and progress of banking in India (various years). CRISIL research. The figures in brackets indicate the percentage to total

11 16917

2.2 Financial Performance of NBFCs

RNBC

NBFC-ND-SI 11177

14000

9353

12000

2755

2399

1847

1885

1298 73.14

1222 75.43

1054 114.67

942.12 179.19

4829 771.28 202.8

745.62 244.52

485.54 231.72

2000

3179

6000

4087

8000

5888

7613

10000

4000

12920

NBFC-D

12226

16000

14832

18000

0 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17

Chart 2.1 Trend in NBFCs’ assets (| billion)

2.2 Financial Performance of NBFCs (i) Asset Growth Despite the decline in the number of NBFCs registered with RBI, the overall assets of NBFCs grew rapidly over the years. During 2006–07 to 2016–17, the total assets of NBFCs-ND-SI increased from |3179 billion to |16917 billion, recording an average rate of growth of 18.2% per annum, and at the same time, the assets of deposit-taking NBFCs increased from |485.54 billion to |2755 billion, registering 19% annual growth, indicating the confidence of public on NBFCs (Chart 2.1 and Table 2.2). However, it is noticed that for the last 3 years, the rate of growth of assets of NBFCsND-SI reduced to 11.4% (Table 2.3). It is also noted that the average growth of assets of RNBCs was negative (i.e. −17.5%) during 2006–07 to 2012–13 (this is the latest year for which data are available). This falling trend may be partially because of tight regulations by the RBI and partially because of subdued demand for gold and construction equipments.1 In future, the growth of NBFC segment is expected to be healthy, but lower than in the past (ASSOCHEM and PwC 2015). (i) Public Deposit The public deposit of NBFCs sector increased marginally from |226.23 billion in 2005–06 to |247 billion in 2006–07. Then, it started declining continuously and reached |100 billion levels in 2011–12 (Chart 2.2). This decline in public deposit 1 The gold loan industry is adjusting to the new regulatory changes, while the construction equipment

loan industry is affected by slowdown in investment (CRISIL 2014).

12

2 Growth and Development of NBFCs

Table 2.3 Annual growth of asset of NBFC (%)

Year

NBFC-D

NBFC-ND-SI

2007–08

53.5

28.6

2008–09

3.4

18.2

2009–10

22.2

21.9

2010–11

11.9

29.3

2011–12

15.9

22.9

2012–13

2.2

19.5

2013–14

50.9

9.4

2014–15

−2

5.7

2015–16

29.9

14.8

2016–17

14.8

14.1

All period

19.0

18.2

Last 3 years

13.5

11.4

40915 42467 1552

1558

3183

10808 14390 3582

3817 7085 10902

2831

5000

1971

10000

2448

15000

NBFCs

4265 5735 10000

20000

NBFCs-D

7902 4098 12000

22358 24400 2042

19595 21566

22622 24699

25000

20175 22623

30000

2077

RNBCs

35000

14521 17352

40000

28941 32124

45000

37914 39472

Source Report on trend and progress of banking in India, RBI; CRISIL research

0 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17

Chart 2.2 Trends in public deposits with NBFCs (| crore)

with NBFCs is in line with RBI’s regulatory pressure plans and largely on account of RNBCs.2 During 2005–06 to 2011–12, the public deposits of RNBCs declined considerably from |201.8 billion to |42.7 billion. At the same time, the public deposits with deposit-taking NBFCs increased from |24.5 billion to |57.4 billion. However, it is noted that in 1997–98 public deposit with NBFCs-D was |529 billion (not shown). It is obvious that the decline during 1997–98 to 2011–12 was much sharper. From 2011–12 onwards, the public deposits of NBFCs increased and reached |424.7 billion in 2016–17, registering 4.25-fold rise. This significant improvement in the public deposit was mainly due to increase in pubic deposits with NBFCs-D. Their public deposit increased from |57.4 billion in 2011–12 to |409.2 billion in 2 Due

to (i) various regulatory measures of RBI and (ii) the development of capital market and enhanced availability of other investment instruments, the public deposits declined.

2.2 Financial Performance of NBFCs

13

5000

4458

4500 3803

4000 3500 3000 2152 1797

2000 1221

1500

500 0

3190

2923

2949

2901

657 583 75

813 732 81

1101 120

1440

221

307

289

4046 3425

2633

2500

1000

3144

3256

2415 1981

1636 1308 161

132

171

218

378

412

2006 -07 2007 -08 2008 -09 2009 -10 2010 -11 2011 -12 2012 -13 2013 -14 2014 -15 2015 -16 2016 -17 2016 -17 NBFC-D

NBFC-ND-SI

Total

Chart 2.3 Growth of net owned funds of NBFCs (| billion)

2016–17, thereby registering 7.13-fold rise. The rapid growth of this along with past growth of assets of NBFCs-D during the latest years clearly indicates the confidence of public in NBFCs due to tight regulations by the RBI. Their focus on niche asset classes along with increase in geographical reach and faster disbursement process would have supported the fast growth of NBFCs, and in turn this would have helped them to gain in their market share. (iii) Net Owned Funds The net owned funds of deposit-taking NBFCs increased considerably from |74.4 billion in 2005–06 to |412 billion in 2016–17 and of NBFC-ND from |583 billion to |4046 billion (Chart 2.3). Thus, the total owned funds of NBFCs increased from |657 billion to |4458 billion, showing a rapid improvement in their financial strength over the years. (iv) Composition of Advances The loans and advances of NBFCs-D were |106.9 billion in 2006. It increased to |1585 billion in 2014 and further to |2450 billion in 2017. During 2014 and 2017, the loans and advances of NBFCs-NI-SI also increased from |8273 billion to |12,396 billion. Thus, the NBFCs have created product niches in infrastructure finance, automobile finance, gold finance, mortgage/housing finance, personal finance and capital markets over the years. The compositions of NBFCs advances for two recent years (2014 and 2017) are shown in Chart 2.4. In 2014, home loans accounted for 30% of total advances, while vehicle finances accounted for 22%. The share of real estate and structural credits and loans against property accounted for 8% each, and the share of gold loan and microfinance was only about 6%. In 2017, the share of home loans increased to 33% while that of vehicle finance slightly declined to 18%. The real estate and structured credit increased to 12%, while the infrastructure finance marginally increased to 5%. The share of loans against property also increased to 10%.

14

2 Growth and Development of NBFCs

2014

2017

Chart 2.4 Composition of NBFCs advances (2014 and 2017). Source CRISIL research 12000

10620

10000

8888 7819

8000

6397

6000

7089

5002 4053

4000 2000

2716 1035

3285 1213

1820

2347

2555

2798

2773

3376

3135

0 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 Bank Borrowing

Market Borrowing

Chart 2.5 Trends in bank and market borrowings by the NBFCs in India (| billion)

(v) Bank and Market Borrowings Borrowing from banks is one of the major sources of funding for NBFCs. The NBFCs’ borrowing from the banking sector increased by about three times from |1035 billion in 2008–09 to |3135 billion in 2016–17, indicating an increased dependency of NBFCs on leverage from banks (Chart 2.5). Other market borrowings (i.e. other than bank borrowings) also increased from |2716 billion to |10620 billion, recording a 3.9-fold rise. Among various sources, borrowings through NCDs constitute the largest source of finance for NBFCs. From 2009 to 2010, funds raised through NCDs registered a significant growth in the cases of infrastructure finance companies and gold loan companies.

2.2 Financial Performance of NBFCs

15

700

660 614

600 520

500 400

552

404 353

319

300

343

248

200 100 0

2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17

Chart 2.6 Trends in bank borrowings (| billion) by NBFCs-D 14

13.9

13.4 12.7

13

12.9

13.1

12.1 12.3

12 11.3

11

10.7

10 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17

Chart 2.7 Proportion of NBFCs assets to bank assets (%)

Increasing interlinkage between banks and NBFCs might have been the reason for why the RBI has introduced additional safeguards to contain systemic risks. However, it is noted that the bank borrowings by the deposit-taking NFBCs increased from |248 billion in 2008–09 to |614 billion in 2016–17 (Chart 2.6). (vi) Market Share of NBFCs and Business Concentration As indicated earlier, the NBFCs have steadily grown in their assets (and relative to GDP). The proportion of NBFCs assets to bank assets has also steadily grown from 10.7% in 2008–09 to 13.9% in 2016–17, thus gaining the systemic importance (Chart 2.7). Their steady growth and increased market share indicate how they are successful in their business models and the opportunities and potential in their target markets. Chart 2.8 shows how the NBFCs’ credit has been growing more rapidly than the banking sector’s. It grew at a rapid pace until 2012–13, after which growth moderated owing to higher base. Banks have grown at a less volatile pace compared with NBFCs. Housing finance companies grew slower than NBFCs until 2011–12. However, they

16

2 Growth and Development of NBFCs

35 29.9

30 25 20

29.3

27.9

20.9 22.9

22

21.8

21.2

19.9

15.3

18.1

15

21.1

18.9

12.7

15.9

14.5

10

11

10 9.7

5

6.9 2.8

0 2010-11

2011-12

2012-13 Banks

NBFCS

2013-14

2014-15

2015-16

2016-17

Housing Financing Companies

Chart 2.8 Credit growth in banks, NBFCs and housing finances (%)

have been growing faster since. The NBFCs’ credit is expected to grow at 7–10% CAGR up to 2022–23 (Assocham and PwC 2015). Unlike banks, NBFCs differ in terms of their size, sophistication of operations and activities undertaken. They include two sets of entities: (i) entities that are part of large multinational groups and (ii) small entities with assets worth |25 lakhs. The study by Vijay Bhaskar (2014) measures the business concentration in terms of total assets and total credits based on Herfindahl–Hirschman index (HHI) using micro-level data for NBFC sector from COSMOS database of the Department of Non-Banking Supervision and data for banking sector from RBI’s Statistical Tables Relating to Banks in India for 2012 and 2013.3 The HHI values shown in Table 2.4 indicate that competition is greater in NBFC sector as compared to the banking sector as HI values for assets as well as for credit of NBFC sector are lower than that for banking sector in both years except the HHI for credit of NBFC in 2012. (vii) Net Profit Growth and Return on Assets The NBFCs have shown a consistent year-on-year growth in net profits over the years. During 2005–06 to 2016–17, the net profit of deposit-taking NBFCs increased from |5 billion to |50 billion, while the net profit of NBFCs-ND-SI increased from |43 billion to |263 billion. The net profit of RNBCs also increased from |1.58 billion to |12 billion during 2005–06 to 2012–13 (Chart 2.9). The effects of market recoveries are 3 The

HHI is calculated by squaring the share of each firm (entity) in total assets (or credit) and then summing the resulting numbers. It varies from 0 to 10,000 with the highest value indicating monopoly and zero indicating perfect competition. In general, if its value is less than 1000, the industry is considered as competitive; if it ranges 1000–1800, the industry is moderately concentrated; if its value is greater than 1800, the industry is highly concentrated.

2.2 Financial Performance of NBFCs

17

Table 2.4 Herfindahl–Hirschman index: business concentration analysis for NBFCs and banks Period

NBFC sector

Banking sector

Total assets

Total credit

Total assets

Total credit

March 2012

372.4

591.8

508.5

545.2

March 2013

407.2

635.1

514.0

879.5

318

350

NBFC-ND-SI

RNBCS

50

2016-17

48

2015-16

46

2014-15

43

2013-14

11.96 34

2012-13

10.96 33

2011-12

9.1 29

2010-11

3.82 14

2009-10

1.98 20

2008-09

3.77 19

2007-08

2006-07

2.01 5

43

2005-06

0

1.58 5

50

75

100

87

108

150

122

160

200

171

222

250

263

270

300

318

Source Vijay Baskar (2014)

NBFCs-D

Chart 2.9 Net profit growth of NBFCs (| billion)

evident, especially in 2013–14. With increased focus on financial inclusion by both government and RBI, one could expect a continued growth of net profit of NBFCs in near future. Chart 2.10 presents the net profit–income ratios for NBFCs-D, NBFCsND and RNBCs over the years. For NBFCs-D, the net profit–income ratio ranged between 8.77 and 19.82% during 2005–06 to 2015–16, while it ranged between 17.31 and 23.85% for NBFCs-ND and between 7.85 and 38.09% for RNBCs. This ratio is highly volatile for RNBCs. The ROA—return on assets (net profit as a percentage of total assets)—of NBFCsND has shown stability with figures ranging around 2% over the years. The ROA of NBFCs-D has also shown stability with a few variations in the figures, ranging between 1.5 and 2.75% during 2007–08 to 2016–17. The ROA of RNBCs seem to be little volatile, ranging between 0.72 and 2.13% during 2005–06 to 2012–13 (Chart 2.11). It is also interesting to note that the return on assets of NBFCs has shown stability with figures ranging 1.6 and 2.4% over the years and is typically higher than that for banks and housing financing institutions on account of low operating costs and no statutory requirements like statutory liquidity ratio (SLR) and cash reserve ratio (CRR). See Chart 2.12.

2 Growth and Development of NBFCs

40

NBFC -ND

RNBC

32.97

NBFC -D

38.09

18

35

13.8

12.3

13.4

15.4

17.8

18.7

18.7

18.32

18.09

18.44

17.31

16.2

21.28

7.85

10.29

18

8.2

10.62

19.08

16.95

20.03

19.63

22.02

19

10

8.77

11.11

15

9.75

20

16.21

23.45

25

23.85

30

5 0 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17

Chart 2.10 Net profit–income ratio: NBFC-D, NBFC-ND and RNBCs NBFC-D

3 2.55

2.5 2 1.5

2.35

2.07

2.3

2.1 1.83

2.13

1.72

2.01

2.1 2.1

2.1

2.09

1.9

1.64

1.32

1.49

1.54

1.03

1 0.5

RNBC 2.72 2.5

2.24

2.13

NBFC-ND 2.7

2.75

2.59

0.98

0.87

1.6

1.45

0.79

0.72

201617

201516

201415

201314

201213

201112

201011

200910

200809

200708

200607

200506

0

Chart 2.11 Trends in return on assets: NBFCs-D, NBFCs-ND and RNBCs 2.4

2.5

2.25 2.1

2.2

2.1 1.9

2

2.1

2.1

1.85 1.6

1.5 1

1.4

1.35 1.13

1.02

1.2 1.05

1.01

1.11 1.08

1

1.1

1 0.8

0.8

0.9

0.9

0.9

0.6 0.4

0.5

0.4

0 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 Banks

NBFCs

NHG

Chart 2.12 Trends in return on assets: NBFCs, banks and NHBs

2.2 Financial Performance of NBFCs

19

NBFCs-D

NBFCs-ND-SI 7

7

6.1

5.96 6

6

4.9 5

5

4 3

3.1 2.2

2.1

-1

3

0.7

1.7 0.8

4.4 3.1

2.4

1.35

4.3

4

1.3

1 0

2.2

2

2

3.5

4.9

1

2.1

1.1

0.5 0.2 0 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17

2

2.9

3 2.3

2.6

2.9

2.2 2.7

1.7

2.5

2 1 1.09

1.25

1.2 0.69

0

1.5

1.7

1

2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17

-1

-1

-2

Gross NPAs to Gross Advances

%Net NPAs to Net Advances %

Chart 2.13 Non-performing asset growth of NBFCs

(viii) Non-Performing Asset Growth of NBFCs The NBFCs have been witnessing a stress in the asset quality over the past 4 or 5 years, particularly the NBFCs-D owing to the economic slowdown and weak operating environment. The gross non-performing asset to gross advances of NBFCs-D was 2.7% in 2008–09 and came down to 0.7% in 2010–11. After that year, it started increasing and reached 5.9% level in 2016–17. The net NPAs relative to net advances also increased steadily from −0.1% in 2010–11 to 2.1% in 2016–17. In the case of NBFCs-ND-SI also, the gross NPA ratio came down from 4.9 to 1.7% from 2006–07 to 2010–11 and the net NPA ratio from 2.5 to 1.2%. After that, both ratios increased considerably. In 2016–17, they were at 6.1% and 4.4% levels, respectively. It is noted that these ratios for NBFCs-D are still higher than that for NBFCs-ND-SI (Chart 2.13). However, given the fact that asset classification norms are constantly being strengthened in the revised regulatory framework, the NPA ratios may differ from the earlier levels. The capital strength of the AFCs is very clear in Table 2.5. Substandard assets stood at 2.6% of the total in 2016–17, and this is much less than the same of the banking system. Even the capital adequacy ratio of NBFCs was robust as most of the NBFCs have CRAR of more than 15% (Table 2.6). This gives a true picture of the financial strength of the AFCs and hence their contribution to the financial stability of the system.

20

2 Growth and Development of NBFCs

Table 2.5 Classification of assets of NBFCs-D by category of NBFCs: asset finance companies Indicators

2009–10

2010–11

2011–12

2012–13

2013–14

2014–15

2015–16

2016–17

(%) Standard assets

99.2

99.5

97.6

97.3

95.7

95.8

95.5

95

Gross NPAs of which

0.8

0.5

2.4

2.7

4.3

4.2

4.5

5.0

Substandard assets

0.6

0.4

1.5

2.1

2.6

2.8

2.6

2.6

Doubtful assets

0.1

0.1

0.6

0.3

1.2

1.1

1.6

2.1

Loss assets

0.1

0

0.3

0.3

0.5

0.3

0.3

0.3

Total credit exposure

100

100

100

100

100

100

100

100

2012–13

2012–13

Source Report on trend and progress of banking in India, RBI; CRISIL research

Table 2.6 Capital adequacy ratio of NBFCs-ND-SI—by type of NBFC 2009–10

2009–10

2010–11

2010–11

2011–12

2011–12

CRAR range

AFC

IFC

AFC

IFC

AFC

IFC

AFC

IFC

(1) Less than 15%

5

–

0

0

–

–

1

–

(2) More than 15% and up to 20%

5

1

5

1

5

1

5

1

(3) More than 20% and up to 30%

21

1

5

2

4

2

4

2

(4) Above 30%

182

1

8

1

7

1

6

1

Total

211

3

18

4

16

4

16

4

(ix) Financial Ratios of NBFCs A summary of selective financial ratios relating to NBFCs is shown in Table 2.7. The overall financial performance of NBFCs-D improved considerably during 2005–06 to 2016–17. While income–asset ratio increased from 11.9 to 14.4% during this period, the expenditure–asset ratio increased from 9.8 to 11.8%. As a result, the cost–income ratio declined from 82.2 to 80.7% and net profit–income ratio increased from 11.1 to 12.7%. The net profit asset ratio also increased from 1.32 to 1.8%. The increase in net profit was mainly on account of the growth in fund-based income and decline in fund-based expenditure. In the case of NBFCS-ND-SI, the financial performances deteriorated over the years. During 2005–06 to 2016–17, while income–asset ratio increased from 7.3

82.2

119

7.3

4.8

43

23.5

1.7

65.0

Expenditure

Income–asset ratio %

Expenditure–asset ratio %

Net profit

Net profit–income ratio %

Net profit–asset ratio %

Cost–income ratio %

65.8

2.4

24.0

75

6.5

9.9

206

313

84.2

1.0

8.8

9.9

11.7

50

48

57

2006–07

69.1

2.1

22.0

87

6.7

9.7

273

395

69.0

2.6

19.0

9.3

13.4

19

69

100

2007–08

73.0

2.2

18.0

108

9.1

12.4

438

600

73.7

2.6

17.0

11.3

15.3

20

87

118

2008–09

71.6

2.1

20.0

122

7.4

10.3

436

609

80.9

1.5

10.3

11.7

14.4

14

110

136

2009–10

Source Report on trend and progress of banking in India, RBI; CRISIL research

183

Income

NFBCs-ND-SI

Cost–income ratio %

9.8

Expenditure–asset ratio %

11.1

11.9

Income–asset ratio %

1.3

5

Net profit

Net profit–asset ratio %

37

Net profit–income ratio %

45

Expenditure

2005–06

Income

NBFCs-D

Indicators

Table 2.7 Financial performances of NBFCs-D and NBFCs-ND-SI (| billion)

1.8 75.4

70.4

17.3

171

8.0

10.6

745

988

72.1

2.7

18.4

10.6

14.7

33

129

179

2011–12

2.1

21.3

160

7.0

9.9

529

752

71.7

2.8

19.1

10.3

14.4

29

109

152

2010–11

81.7

2.0

18.3

233

9.0

11.0

1,039

1,272

73.4

2.7

18.1

11.1

15.1

34

138

188

2012–13

74.3

2.1

18.7

270

8.4

11.3

1,071

1,443

76.6

2.5

19.8

11.8

15.4

43

166

217

2013–14

77.8

2.1

18.7

318

8.3

11.2

1,257

1,702

77.9

2.3

14.6

11.6

14.9

41

220

280

2014–15

75.3

2.1

17.8

318

9.1

12.0

1,343

1,785

79.8

2.0

13.7

11.9

14.9

49

285

357

2015–16

78.5

1.6

13.8

263

8.9

11.3

1,498

1,909

80.7

1.8

12.7

11.8

14.4

51

324

401

2016–17

2.2 Financial Performance of NBFCs 21

22

2 Growth and Development of NBFCs

Table 2.8 Financial performances of RNBC (| billion) Indicators

2005–06

2006–07

2007–08

2008–09

2009–10

2010–11

2011–12

2012–13

Income

16

19

23

24

19

116

33

31

Expenditure

14

16

17

21

14

101

17

15

Net profit

2

2

4

2

4

9

11

12

Income–asset ratio %

7.31

8.2

9.41

11.83

10.6

101.2

43.75

42.38

Expenditure–asset 6.4 ratio %

6.91

6.96

10.35

7.81

88.08

22.54

20.51

Net profit–income ratio %

12.5

10.53

17.39

8.33

21.05

7.76

33.33

38.71

Net profit–asset ratio %

0.72

0.87

1.54

0.98

2.13

7.85

14.58

16.41

Cost–income ratio %

87.5

84.21

73.91

87.5

73.68

87.07

51.52

48.39

Source Report on trend and progress of banking in India, RBI

to 11.3%, the expenditure–asset ratio increased from 4.8 to 8.9%. As a result, the cost–income ratio also increased from 65 to 78.5%. The net profit relative to income declined from 23.5 to 13.8%. But net profit relative to asset increased from 1.72 to 1.6%. However, it is noted that this ratio varied over the years and compares well with the ratio for NBFCs-D in some years and poorly in some other years (Table 2.8). The financial performances of RNBCs were better than that of NBFCs-D. During 2005–13, their income–asset ratio increased from 7.31 to 42.38%, while their expenditure–asset ratio from 6.4 to 20.51%. The cost–income ratio declined considerably from 87.5 to 48.4%, and so the net profit–income ratio increased from 12.5 to 38.71%. The net income–asset ratio also improved significantly from 0.72 to 16.41%.

2.3 Balance Sheet of NBFCs-D Table 2.9 presents major components of the balance sheets (assets and liabilities) of NBFCs-D over the years. The paid-up capital increased from |18.27 billion in 2005 to |38 billion in 2009–10. After that year, it started decreasing and reached |33 billion in 2016–17. Its share in total assets declined from 4.83 to 1.2% during 2005–17. Although the share of reserves declined from 14.87 to 12.8% during 2005–06 to 2010–11, it increased to 13.8% in 2016–17. Public deposits which are subject to credit rating also revealed a similar trend. It declined from 6.41% in 2005–06 to 3% in 2009–10, then started continuously raising and reached a peak of 11.1% in 2016–17. Borrowings accounted for a major share in total liabilities. Its share was 65.94% in 2005–06 and declined to 22.3% in 2016–17. It is, however, noted that in recent years,

4.28

2.74

–

–

–

Intercorporate borrow

Commercial paper

Borrowing from government

–

–

–

–

–

–

–

–

67.83

505.77

–

2.56

–

–

–

–

72.47

558.97

–

–

–

–

–

68.01

640.78

–

3

28.31

–

–

–

–

66.22

698

–

3.89

41

12.81

238

4.66

57

14.89

182

55

29

4

5

33.06

–

66.84

324.52

–

19.71

12.93

135

2.95

36

Borrowings from FIs

Debenture

20.42

12.2

121.81

3.04

32

65.94

6.47

–

% share of total liabilities

20.77

11.66

94.12

4.13

38.92

2011–12

% share of total liabilities

24.47

Public deposits

12.07

86.95

4.95

38.17

2010–11

404

14.87

% share of total liabilities

58.61

4.38

32.66

2009–10

19.48

56.25

Reserves and surplus

4.67

22.68

2008–09

249.42

4.83

% share of total liabilities

2007–08

Bank borrowings

18.27

Share capital

2006–07

% share of total liabilities

2005–06

Items

Table 2.9 Assets and liabilities of NBFCs-D (Consolidated balance sheet in | billion)

43

29

3

15

27.46

343

25.46

318

5.68

71

14.57

183

2.96

38

2012–13

38

93

1

16

27.59

520

22.12

417

13.8

260

14.54

274

1.75

33

2013–14

38

58

2

16

29.9

552

21.1

389

14.6

270

14

258

1.68

31

2014–15

30

66

6

23

27.5

659

22.5

539

11.3

271

14.3

343

1.5

35

2015–16

(continued)

0

148

14

31

22.3

614

24.2

668

11.1

306

13.8

380

1.2

33

2016–17

2.3 Balance Sheet of NBFCs-D 23

12.61

3.33

Other assets

% share of total assets

5.12

24.88

–

–

15.27

74.12

–

22.78

110.59

485.54

58.95

–

–

–

–

2006–07

13.34

99.44

–

–

15.03

112.1

–

25.24

188.21

745.62

99.82

–

–

–

–

2007–08

4.42

34.07

–

–

20.34

156.86

–

27.98

215.83

771.28

60.31

–

–

–

–

2008–09

4.83

45.5

–

–

19.63

184.98

–

75.49

711.19

942.12

112.29

–

–

–

–

2009–10

5.98

63

–

–

20.02

211

–

74

780

1054

144

–

–

–

–

2010–11

1.88

23

103

144

6.06

74

37

68.82

841

1222

0

37

92

29

55

2011–12

Source Reports on trend and progress of banking in India, RBI (various years), and CRISIL research

–

11.44

% share of total assets

–

43.26

Investments

Other current assets

–

Cash and bank balances

28.25

Hire purchase/lease assets

29.87

Other liabilities

% share of total assets

–

Provisions

378.28

–

Current liabilities

106.86

–

Other borrowings

Loans and advances

–

Subordinated debt

Total liabilities/assets

2005–06

Items

Table 2.9 (continued)

1.6

20

71

146

5.76

72

22

73.5

920

1251

0

41

70

34

62

2012–13

1.06

20

54

122

3.1

58

46

84

1585

1885

0

46

54

53

79

2013–14

0.8

16

52

120

3.7

69

39

86

1590

1847

0

51

58

49

76

2014–15

0.7

17

70

100

3.8

92

45

86.4

2,073

2,399

0

79

79

179

88

2015–16

–

92

88

4.5

125

44

87.3

2,405

2,755

0

103

95

246

119

2016–17

24 2 Growth and Development of NBFCs

2.3 Balance Sheet of NBFCs-D 2011-12

25 2016-17

Chart 2.14 Type of investments (NBFCs-D): 2011–12 and 2016–17

there has been an increase in other borrowings (i.e. commercial paper, intercorporate borrowings, borrowings from government, etc.). Loans and advances of NBFCs-D increased from |106.86 billion in 2005–06 to |2450 billion in 2016–17. Its share in the total assets increased from 28.3 to 88.9% during this period. Thus, the growth in loans and advances has been predominant as compared to other items. In order to have a control on the balance sheet, it is important to monitor the growth of loans and advances on the asset side and borrowings on the liability side. Investments increased from |43.26 billion in 2005–06 to |125 billion in 2016–17, but its share declined from 11.44 to 4.5% during this period. The investment increase seen during this period is due to the increase of SLR investments, as specified by the RBI. It is noticed from Chart 2.14 that majority of investments are made on government securities (about 35%), mutual funds (28%) and equity (22%). If we analyse the major components of liabilities of NBFCs-D by their categories, we can observe that asset finance companies had a major share. This predominance can also be noticed in public deposits, borrowings and total liabilities (Table 2.10). As mentioned earlier, NBFCs were reclassified in December 2010. Strictly speaking, the figures after 2009–10 are not comparable with that for earlier years. Even after the new classifications, the asset financing companies’ share is dominant. Table 2.11 shows the financial leverage ratios of NBFCs-D from 2005–06 to 2016–17. While the proportion of debt in the balance sheet declined from 72% in 2005–06 to 58% in 2016–17, the debt–equity ratio increased from 3.68 to 3.9%

Asset finance

68.4

2007–08

5.8

2.1

8.9

56.9

2005–06

2006–07

2007–08

0.5

8.7

2004–05

Public deposits

0.7

2006–07

0.2

9.8

50.9

2005–06

13.1

Equipment leasing

2004–05

Total liabilities

Year

8.3

81

6.4

61.7

0.2

35.8

80.7

56.9

Hire purchase

0.9

2.2

3

2.4

0.5

3.4

4.5

5.2

Investment

33.4

5.6

2.9

5.2

30.6

9.3

3.9

19.3

Loan

20

20

26

39

746

485

378

360

Total (| billion)

Table 2.10 Major components of liabilities of NBFCs-D by classification of NBFCs (% share in total)

28

379 409

2016–17

(continued)

289 2015–16

71

57

41

2014–15

20

24

10.6

19

108

80

76

89.4

19.2

2013–14

2012–13

2011–12

2010–11

2009–10

21.2

2,755

2016–17

80.8

2,399

78.8

1848

2015–16

2008–09

1885

2014–15

1222

1054

942

771

Total (| billion)

2013–14

31

29.8

35.4

26.7

Loan

1251

69

70.2

64.6

73.2

Asset finances

2012–13

2011–12

2010–11

2009–10

2008–09

Years

26 2 Growth and Development of NBFCs

Equipment leasing

0.4

67.4

2006–07

2007–08

0.1

32.9

82.6

58.1

Hire purchase

0.7

0.4

2.9

4.7

Investment

31.7

7.4

4.4

20.2

Loan

Source Report on trend and progress of banking in India, RBI; CRISIL research

0.2

9.8

58.6

2005–06

13.5

Asset finance

2004–05

Borrowings

Year

Table 2.10 (continued)

506

325

236

230

Total (| billion)

1181 1592 1839

2015–16 2016–17

848

818

698

641

558

Total (| billion)

2014–15

14

29

29.8

34.6

27.2

Loan

1219

86

71

70.2

65.4

72.8

Asset finances

2013–14

2012–13

2011–12

2010–11

2009–10

2008–09

Years

2.3 Balance Sheet of NBFCs-D 27

28

2 Growth and Development of NBFCs

during the same period. This implies that the quality of assets will have a great impact on servicing the interest obligations of borrowings and further reiterates the need to monitor the asset quality and reduce NPAs. Public deposits mobilized by NBFCs were one of the debatable items in the liabilities of the NBFCs, as they posed serious competition with the banks. But it is a good thing that the RBI has mandated the credit rating of NBFCs so that investing public can compare the financial strength of the NBFCs before they take a suitable investment decision. While rating is a good exercise, the modus operandi followed and the cost–benefit analysis for the small NBFCs raise some important issues, which merit attention. However, it is interesting to note that about 3% of the NBFCsD attracts deposits of |50 crore and above. But interestingly, the deposit amounts in the range of |50 crore and above account for about 80–90%. The degree is very predominant, as seen in the case of banking (Table 2.12). However, it is noticed these data are available till 2012–13 only. Thus, Table 2.12 clearly shows that only big NBFCs-D could attract this kind of high amount of deposits. Until a decade ago, the NBFCs were only marginal players with a small resource base. Currently, some of the leading NBFCs are equivalent to or larger than many mid-sized banks. Particularly, the equity of many leading finance companies is comparable with many mid-sized banks. An analysis of deposits on the basis of interest rates in Table 2.13 indicates that there is a clear shift in terms of deposits with more than 10% rate and less than 12%. The NBFCs faced some serious problems in 2007–08, they offered high rate, and this was responsible for the shift in the share of deposits with 10–12% in 2008–09, but thereafter this declined. But in the last 2/3 years, again the share of deposits of this group increased and a considerable decline in the share of deposits up to 10% was witnessed. This could be due to enhanced awareness among the depositors, and this is in line with increased inflation during this period. Due to the regulatory pressure, the share of high-end interest rate deposits is almost maintained below 2%, which is a welcome thing. Major portions of the deposits were kept for less than 3 years (about 90% in 2012–13). A very small portion of the public deposits was kept for 5 years and above (less than 2%). In the last 3 years, the share of deposits for 2–3 years has been increasing. No doubt this will give some kind of stability for NBFCs-D (Table 2.14). The weighted maturity years of the deposits are almost constant at 2–3 years during 2007–08 and 2012–13. Banks and financial institutions have been the dominant source of borrowings for NBFCs-D, comprising over 44% share in overall borrowings in 2008–09. However, this share has been constantly declining and stood at ~35% in 2016–17. Between 2011–12 and 2016–17, other sources, which comprised money borrowed from other companies, CPs and borrowings from mutual funds increased significantly. It is important to note that this item is not treated as ‘public deposits’. NBFCs have been able to raise money through debentures at lower costs, improving their net interest margins and thus raising the share of debentures in overall borrowing (Table 2.15).

72

3.68

Debt-to-total asset ratio (%)

Debt–equity ratio

4.25

71

2006–07

4.4

71

2007–08

4.37

75

2008–09

4.16

71

2009–10

Note Debt comprises of public deposits, debentures and bank borrowings

2005–06

Ratio

Table 2.11 Debt-to-asset ratio and debt–equity ratio (NBFCs-D)

4.43

70

2010–11

3.21

57

2011–12

3.34

59

2012–13

3.9

64

2013–14

4.2

66

2014–15

3.9

61

2015–16

3.9

58

2016–17

2.3 Balance Sheet of NBFCs-D 29

15

2.1

700

|50 crore and above

%

Total

1.1

195

5

375

9.6

%

|0.5–2.0 crore

%

|.2.0–10.0 crore

%

43

Less than |0.5 crore

Amount of deposits (| crore)

2.6

|10.0–20.0 crore

%

18

%

2.57

12

|2.0–10.0 crore

18

84

%

|20.0–50.0 crore

28.1

|0.5–2.0 crore

%

52.6

197

%

368

2004–05

Less than |0.5 crore

Number of NBFCs

Deposit range

7.5

201

4.3

116

1.4

37

463

2.4

11

1.3

6

3.02

14

10.4

48

25.9

120

57

264

2005–06

7.8

161

4.1

86

1.5

31

373

1.9

7

1.3

5

1.88

7

9.7

36

24.7

92

60.6

226

2006–07

Table 2.12 Public deposits held by NBFCs-D by deposit ranges

9.1

186

4

82

1.4

28

350

2.3

8

0.6

2

1.14

4

10.9

38

24.3

85

60.9

213

2007–08

6.7

133

2.8

55

1.2

23

288

2.1

6

1.4

4

2.08

6

10.4

30

19.8

57

64.2

185

2008–09

4.5

128

2.3

64

0.7

21

290

3 4

10

1.4

4

1.72

5

9.3

27

20.7

60

63.4

184

2009–10

3.2

1287

1.1

442

0.5

194

217

3.7

8

0.9

2

3.23

7

12.9

28

17.5

38

61.8

134

2010–11

2

1131

0.9

490

0.3

187

242

2.5

6

1.7

4

2.89

7

11.2

27

18.6

45

63.2

153

2011–12

(continued)

1.7

1197

0.6

407

0.2

156

209

2.9

6

1

2

2.87

6

13.4

28

18.7

39

61.2

128

2012–13

30 2 Growth and Development of NBFCs

265

6.75

601

15.3

2,447

62.3

3,926

|10.0–20.0 crore

%

|20.0–50.0 crore

%

|50 crore and above

%

Total

2,667

71.9

1,917

7.5

199

7.35

196

2005–06

2,077

73.6

1,529

8.5

177

4.48

93

2006–07

2042

79.8

1629

2.7

56

2.99

61

2007–08

1,971

78.3

1,543

7.2

142

3.86

76

2008–09

2,831

85.3

2,416

4.7

133

2.44

69

2009–10

40,623

90.6

36,809

2

807

2.67

1084

2010–11

57,045

92.8

52,951

2.1

201

1.9

1085

2011–12

70,851

95.5

67,682

0.7

482

1.31

928

2012–13

Source Reports on trend and progress of banking in India (various years). This table is based on the number of NBFCs submitted their annual reports in that year

2004–05

Deposit range

Table 2.12 (continued)

2.3 Balance Sheet of NBFCs-D 31

22.96

588.5

7726.5

8338

Up to 10

10–12

More than 12

Total

3926

377

853

2696

2004–05

2667

134

310

2224

2005–06

2077

36

202

1839

2006–07

Source Reports on trend and progress of banking in India (various years)

1999–2000

Interest range

113 1971

2042

1267

591

2008–09

33

518

1491

2007–08

Table 2.13 Public deposits held by NBFCs-D: interest rate range-wise (Amount in | crore)

2831

93

1222

1516

2009–10

40,623

1200

9454

26,963

2010–11

57,045

821

23,750

32,473

2011–12

70,851

1150

43,816

25,885

2012–13

32 2 Growth and Development of NBFCs

2667

100

20.6

8,338

100

Total 100

2077

3.8

80

11.3

234

27

561

23

477

34.9

724

2006–07

100

2042

3.2

66

10.3

211

32.5

663

24

491

29.9

611

2007–08

Source Reports on trend and progress of banking in India (various years)

0.1

3

14.7

360

%

1,218

3–5 years

22.8

559

14.6

29.5

%

1,718

2,462

2–3 years

26.5

5 years and above

19.4

%

648

35.9

878

2005–06

%

15.9

1,616

1–2 years

1,323

Less than 1 year

%

1999–2000

Maturity period

100.0

1971

4.5

88

3.8

74

30.5

601

25.8

509

35.5

700

2008–09

100

2831

3.2

90

2.9

81

36.4

1031

21

595

36.5

1034

2009–10

100

40,624

1.9

769

5.5

2221

48.9

19,877

19.6

7942

24.2

9816

2010–11

Table 2.14 Percentage distribution of the maturity pattern of public deposits held by NBFCs-D (Amount in | crore)

100

57,045

0

6

10.9

6191

43.7

24,940

26.5

15,133

18.9

10,775

2011–12

100

70,851

1.6

1148

9.2

6550

45

31,858

18.2

12,917

25.9

18,379

2012–13

2.3 Balance Sheet of NBFCs-D 33

248

132

146

559

External sources

Banks and FIs

Debentures

Others

Total borrowing

641

118

150

319

8

47

2009–10

698

143

143

353

–

59

2010–11

819

88

238

409

29

55

2011–12

848

100

318

358

29

43

2012–13

1,219

134

417

536

93

38

2013–14

1,181

127

389

569

58

38

2014–15

Note Others include intercorporate bonds, subordinate debts and other borrowings; CPs indicate external sources of borrowing Source Report on trend and progress of banking in India, RBI; CRISIL research

18

15

Government

2008–09

Details

Table 2.15 Sources of borrowings by NBFCs-D (| billion)

1,592

274

539

683

66

30

2015–16

1,839

378

668

645

148

0

2016–17

34 2 Growth and Development of NBFCs

2.4 Balance Sheet of NBFCs-ND-SI

35

2.4 Balance Sheet of NBFCs-ND-SI Loans and advances and investments accounted for about 82 of total assets in 2013–14. On the liability side, borrowings accounted for 70% while the reserve and surplus accounted for 20% (Table 2.16). In 2016–17, the share of loans, advances and investments in total assets increased to 70.4%, while the share of borrowing increased marginally to 18.5%, but the share of reserve and surplus declined marginally to 18.5%. The rapid growth of NBFCs-ND-SI was made possible due to the borrowings mainly from banks and FIs. Hence, the systemic link between banks/FIs and NBFCND-SI hosts a series of challenge to the financial system. Indirectly, the bank depositors are at risk if there is any incipient risk emerging in this particular sector. Hence, the RBI decision to place the cap on bank lending to NBFCs may constrain their growth, but this addresses the concentration risk. The leverage ratio of NBFCs of ND-SI stood at 3.2%. The capital market exposure increased to |1371 billion in 2015–16, which is no doubt a significant contribution.

Table 2.16 Assets and liabilities of NBFCs-ND-SI (Consolidated balance sheet) Item

2013–14 (| billion)

% of asset

2014–15 (| billion)

% of asset

2015–16 (| billion)

% of asset

2016–17 (| billion)

% of asset

Share capital

699

5.5

812

5.3

726

4.9

922

5.5

Reserves and surplus

2,469

19.4

2,818

18.5

2,699

18.2

3,124

18.5

Total borrowings

8,916

70

10,853

71.3

10,661

71.9

11,917

70.4

Current liabilities and provisions

657

5.2

749

4.9

746

5

954

5.6

Total liabilities/assets

12,742

100

15,232

100

14,832

100

16,917

100

Loans and advances

9,367

73.5

10,145

66.6

11,039

74.4

12,396

73.3

Investments

2,081

16.3

2,503

16.4

2,172

14.6

2,555

15.1

Cash and bank balances

382

3

535

3.5

485

3.3

698

4.1

Other current assets

730

5.7

1,850

12.1

952

6.4

1,020

6

Other assets

183

1.4

199

1.3

223

1.5

264

1.6

Memo items Capital market exposure (CME)

897

1,030

1,371

N.A.

CME to total assets

7.3

8

9.6

N.A.

Leverage ratio

3.2

3.5

3.4

N.A.

36

2 Growth and Development of NBFCs

2.5 Summing Up This chapter has extensively reviewed the growth and development of NBFCs sector in India over the years and its performance. So far, the NBFCs have scripted a great success story. Their contribution to the nation has grown from about 8.4% in 2006 to above 13% in 2017. The NBFCs financial assets have also recorded a healthy growth—a compound growth rate of 17% over the past few years—comprising 16% of the total credit and expected to reach nearly 18% in 2018–19 (PwC 2016). The NBFCs are mostly dependent on banks with 50% of their total funds from the banking system. After the global financial crisis, they began to tap the markets for funds. The surges in liquidity at mutual funds and insurers’ investments in bonds have made their funding a better proposition. Today, most large NBFCs have more than 50% of funds as market borrowings. This has enabled them to get funds cheaper. The NBFCs loans and advances increased by 12.8% in 2017, and investments rose by 20.6%. They also managed their asset quality better than banks. Their gross bad loan as % of total advances was 6.1% as on March 2017. Their net NPAs as % of total advances were 4.1%. Despite their achievements and well-known recognition of the important role played by NBFCs in overall financial intermediation, the path of the development NBFCs, however, had been fraught with several challenges. The RBI’s regulations over the past decades—particularly in the past three decades—caused severe pressure on the development of this sector. That was the reason why the number of registered NBFCs-D with the RBI declined considerably from 428 in 2000 to 179 in 2017. In 2005–06, the public deposit of NBFCs sector was |226.23 billion and it declined to |100 billion levels in 2011–12. But due to their constant efforts in raising customers’ confidence, in 2016–17, it went up to |424.7 billion. With the ongoing stress in the banking sector, particularly in the public sector banks due to mounting non-performing assets or bad loans, their chance to lend especially in rural areas will deteriorate. This will provide more opportunities for NBFCs to grow faster. The success of NBFCs could be clearly attributed to their better product lines, lower cost, wider and effective reach, strong risk management capabilities to check and control bad debts, and better understanding of their customer segments.

Chapter 3

Regulatory Developments and Prudential Norms

3.1 Need for Regulation Non-bank financing companies form an integral part of the Indian financial system. In addition to banks, NBFCs also provide funding for various important economic activities, thereby contributing to the growth of the Indian economy. By this process, the NBFCs provide a healthy competition to the banks in terms of various service parameters. But one cannot ignore the fact that the NBFCs may contribute to the systemic risks because of their financial connections with the banks. “If the NBFCs are involved in bank-like activities including transforming maturity/liquidity and creating leverage like banks, this may be a major source of systemic risk, both directly and through its interconnectedness with the banking system” (FSB 2017). Therefore, it is important for the regulator to control these risks by setting up a proper regulatory framework. One of the important objectives of such regulation is to strike a right balance between the risks and benefits associated with the operation of NBFCs. There is no argument that NBFCs cannot be subject to the same degree of regulations as banks, as we have learnt from the Asian crisis in the late nineties on the one hand and, on the other hand, too strict or inappropriate regulations can hinder their growth due to lack of financial innovation and development. Therefore, striking the right balance has always been a challenge for financial regulators/supervisors, particularly in the developing economies like India. This chapter traces the regulatory developments of NBFCs in India over the past few decades.

3.2 Tracing the NBFC Regulatory Path The Reserve Bank of India (RBI) has been regulating the non-banking financial companies (NBFCs) since 1963 under the provisions of Chapter IIIB of the RBI Act (1934), which was basically to regulate deposit accepting NBFCs. As this regulatory © Springer Nature Singapore Pte Ltd. 2019 R. Kannan et al., Non-Banking Financial Companies Role in India’s Development, India Studies in Business and Economics, https://doi.org/10.1007/978-981-13-3375-0_3

37

38

3 Regulatory Developments and Prudential Norms

framework did not cover their functional diversity and expanding intermediation, it seemed to be inadequate to control all types of NBFCs. Therefore, the Working Group on Financial Companies (Shah Working Group) which submitted its report in September 1992 recommended certain measures towards an appropriate regulatory framework for NBFCs and for vesting more powers with the RBI for better and more effective regulation of NBFCs. Based on the recommendations of the Working Group on Financial Companies constituted in April 1992 (Shah Committee), NBFCs with net owned finds (NOFs) of |50 lakh and above were subject to mandatory registration with the RBI since April 1993. In June 1994, prudential norms pertaining to income recognition, asset classification and provisioning were prescribed. In order to suggest suitable off-site surveillance and on-site examination system for NBFCs, the RBI also constituted an expert group (Khanna Committee) in April 1995. A more comprehensive and enhanced framework was put into place in 1996 and 1997. The amended Act, inter alia, provided for minimum NOF for all NBFCs. Through this Act, the RBI acquired powers to determine policies and issue directions to NBFCs regarding income recognition, accounting standards, NPAs, capital adequacy, deployment of funds, etc. The original capital requirement for new entrants increased from |25 lakh to |200 lakh in 1999. In 2006, based on their asset size, the non-deposit accepting NBFCs were further classified into (i) systemically important NBFCs and (ii) nonsystemically important NBFCs, so as to close the gap between banks and NBFCs. Certain prudential norms were imposed on such NBFCs, and consequently, the focus of RBI was equally on deposit accepting NBFCs and non-deposit accepting NBFCs, so as to strengthen the NBFCs contribution to the financial stability of the system. In the meantime, the global financial crisis brought out the severity and the true magnitude of the risks that the shadow banking sector exposed at the global level. It is important to recognize that in India NBFCs are subject to strict regulatory supervision of the RBI and hence cannot be compared with the term ‘shadow banking’ used in other jurisdictions. In many countries, as shadow banking was subject to light-touch regulations, they were prone to high leverage and sub-credit assets. This feature along with the resultant liquidity crunch got further transferred to the banking system due to its interlinkages with the rest of the financial sector. This induced an increased need for a collective effort to preserve the financial stability. “The G20 leaders at the November 2010 Seoul Summit also highlighted ‘strengthening regulation and supervision of shadow banking’. The Financial Stability Board (FSB) has been constantly working towards strengthening the oversight and regulation of the shadow banking system to mitigate the risks arising therefrom” (PwC 2016). Following these initiatives, the RBI and various other regulators and the government have been working towards improving the regulatory framework to avoid the negative effects of shadow banking activities observed elsewhere that pose a risk to the financial stability. At the same time, the RBI has duly recognized the important role played by NBFCs in achieving the financial inclusion agenda in the country. The NBFCs in fact fill the important gaps in the financial inclusions by catering to geographies and sectors where regular banks are unable to cover. Therefore, the

3.2 Tracing the NBFC Regulatory Path

39

Chart 3.1 Chronological detail of key regulatory changes for NBFCs. Source PwC (2016)

RBI took various initiatives to revamp the NBFC framework in the country and it appointed many committees in the past to provide useful recommendations on the role of NBFCs in the development of financial sector and overall growth potential of the country and on the regulatory changes needed to remove or reduce inefficiencies existing in this sector. Based on the recommendations, the RBI has been suitably modifying its regulatory and supervising policies from time to time (PwC 2016). A chronological detail of these regulatory changes is given briefly in Chart 3.1. Details of recommendations of various committees, working groups, etc., are discussed in detailed way below.

3.3 Shah Working Committee Shah Committee’s important recommendations include, inter alia, compulsory registration of NBFCs and a minimum NOF of |25 lakh as entry point norm, maintenance of liquid assets by NBFCs as a percentage of their deposits in government securities/guaranteed bonds, creation of a reserve fund and compulsory transfer of at least 20% of the net profits to this fund, authorizing Company Law Board (CLB) to direct a defaulting NBFC to repay deposits.

40

3 Regulatory Developments and Prudential Norms

Consequent to the implementation of Shah Committee recommendations, the RBI acquired the powers to issue directions to NBFCs regarding their compliance with the prudential norms. It also acquired power to issue directions to NBFCs and to their auditors on their balance sheet matters, to undertake special audit if needed and to impose penalty on erring auditors, thereby prohibiting the NBFCs from accepting deposits for violation of the provisions of the RBI Act. The RBI also acquired power to direct the NBFCs not to alienate their assets, file winding-up petition against NBFCs for violations of the provision of the Act/directions and impose penalty directly on NBFCs for non-compliance with the provisions of the Act. While the NBFCs accepting public deposits were subject to the complete set of regulations, the NBFCs not accepting public deposits were subject to partially, that is in a limited manner. Thus, the focus of the regulatory mechanism was primarily on NBFCs accepting public deposits. At the same time, borrowings by way of intercorporate deposits, issue of secured debentures/bonds, deposits from shareholders by a private limited company and deposits from directors by both public and private limited companies were not considered as public deposits. The Reserve Bank regulations on quantum, the rate of interest, period of deposits, etc., were relevant only to public deposits. The overall ceiling on NBFCs borrowing was removed and was decided on the basis of capital adequacy requirements. The quantum of public deposits that can be raised by NBFCs was directly linked to the level of credit rating. If an NBFC intended to accept public deposits, it should maintain a minimum prescribed credit rating from any of the approved credit rating agencies. The NBFCs having NOF of less than |. 25 lakh have been prohibited from accepting deposits from the public. In order to streamline the working of NBFCs which held public deposits in excess of their new entitlements, a period of 3 years was allowed to these companies to reduce/regularize their excess deposits, subject to the condition that at least 1/3rd of excess should be reduced every year commencing from December 1998, and to wipe out the entire excess by 31 December 2000. The NBFCs having investment grade credit rating were allowed to accept fresh public deposits and renew such maturing deposits, while the NBFCs, which do not have the minimum credit rating or are not rated, were allowed only to renew maturing public deposits. The NBFCs were not allowed to offer an interest rate exceeding 16% per annum and a brokerage fee over 2% on public deposit. Having regard to the risk profile of the assets of NBFCs, the capital adequacy was enhanced from 8 to 10% with effect from 1 April 1998 and further to 12% with effect from 1 April 1999.

3.4 Khanna Committee Consequent to the recommendations of the Khanna Committee (1995), the main thrust of supervision of NBFCs was through an off-site surveillance mechanism. The Reserve Bank had worked out a comprehensive inspection arrangement and also devised special formats for off-site reporting/monitoring. The formats of the

3.4 Khanna Committee

41

annual returns were revised to seek additional details relating to core assets/income of the companies. In order to enhance the authenticity of the data furnished in the returns, the Reserve Bank stipulated that these returns should be certified by the auditors of the company. The objective reporting of the auditors was a critical input for monitoring the activities of NBFCs. Further, companies with asset size of |. 100 crore and above were asked to submit an annual return showing the comparative picture of their operational data for 3 years on several balance sheet items, profit and loss accounts and certain key ratios. On-site inspection of NBFCs with public deposits of |50 crore and above was done annually and the other NBFCs by rotation. On-site inspections were also carried out based on the CAMELS methodology (Capital Adequacy, Asset Quality, Management, Earnings, Liquidity, and Systems). The CAMELS approach reoriented on-site inspection processes towards an intensive examination of the assets of NBFCs, besides their liabilities. In the 1990s, the NBFCs sector grew rapidly due to their high degree of orientation towards customers and their simplified sanction procedures. The NBFCs generated a large clientele base by offering relatively attractive rates of return. However, in the process, what happened was that some of the NBFCs became unsustainable. NBFCs were also displayed a high degree of flexibility in meeting the credit needs of their customers in specific sectors like equipment leasing, hire purchase, housing finance and consumer finance, because they found high gaps between the demand and the supply of funds. As a result, the distinction between banks and NBFCs narrowed in one sense.

3.5 Usha Thorat Working Group The RBI has appointed a working group under the chairmanship of Mrs. Usha Thorat entitled “Issues and Concerns in the NBFC Sector”, and the report was released on 29 August 2011. The key recommendations of this working group that have strong implications for the working and contribution of NBFCs were: • “The minimum net owned fund (NOF) requirement for all new NBFCs wanting to register with the Reserve Bank could be retained at present |. 20 million till the Reserve Bank of India Act is amended. The Reserve Bank of India should, however, insist on a minimum asset size of more than |500 million for registering any new NBFC. • Existing NBFCs below this limit may deregister or be asked to seek a fresh Certificate of Registration at the end of 2 years. • NBFCs not accessing public funds may be exempted from registration provided their assets are below |10 billion.

42

3 Regulatory Developments and Prudential Norms

• Any transfer of shareholding, direct or indirect, of 25% and above, change in control, merger or acquisition of any registered NBFC should have prior approval of the RBI.1 • The twin criterion of assets and income for determining the principal business of an NBFC should be increased to 75% of the total asset and 75% of the total income, respectively. A time period of 3 years may be given to fulfil revised principal business criteria. • Tier I capital for capital-to-risk-weighted asset ratio (CRAR) purposes may be specified at 12% to be achieved in 3 years for all registered NBFCs. • Liquidity ratio may be introduced for all registered NBFCs such that cash, bank balances and holdings of government securities fully cover the gaps, if any, between cumulative outflows and cumulative inflows for the first 30 days. • Asset classification and provisioning norms similar to banks to be brought in a phased manner for NBFCs. Suitable income tax deduction akin to banks may be allowed for provisions made under the regulations. Accounting norms applicable to banks may be applied to NBFCs. • NBFCs may be subject to regulations similar to banks while lending to stockbrokers and merchant banks and similar to stockbrokers, as specified by the Securities and Exchange Board of India (SEBI) while undertaking margin financing. • The financial conglomerate approach may be adopted for supervision of larger NBFCs that have stockbrokers and merchant bankers in the group. • Government-owned entities that qualify as NBFCs may comply with the regulatory framework applicable to NBFCs at the earliest. • Board-approved limits for bank’s exposure to real estate may be made applicable to the bank group as a whole, where there is an NBFC in the group. The risk weights for NBFCs that are not sponsored by banks or that do not have any bank as part of the group may be raised to 150% for capital market exposures and 125% for commercial real estate (CRE) exposures. In case of bank-sponsored NBFCs, the risk weights for capital market exposures (CME) and CRE may be the same as specified for banks. • NBFCs may be given the benefit under Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 (currently, the benefits, e.g. enforcement of security interests utilizing the favourable provisions of the SARFAESI Act, are restricted to banks and certain financial institutions). • Captive NBFCs, the business models of which focus mainly (90% and above) on financing parent company’s products, may maintain Tier I capital at 12% from the time of registration. Supervisory risk assessment of such companies should take into account the risk of the parent company. • For the purpose of applicability of registration and supervision, the total assets of all NBFCs in a group should be taken together to determine the cut-off limit of |. 1 billion. 1 Currently,

only change in control of deposit accepting NBFCs requires prior approval of the RBI.

3.5 Usha Thorat Working Group

43

• All NBFCs with assets of |10 billion and above, whether listed or not, should be required to comply with Clause 49 of SEBI Listing Agreements including mandatory disclosures (this will bring even unlisted NBFCs on a par with public listed companies in terms of corporate governance norms, e.g. board independence, audit committee and periodic financial disclosures). • Disclosure for NBFCs with assets over |1 billion may include provision coverage ratio, liquidity ratio, asset–liability profile, the extent of financing of parent company products, movement of non-performing assets (NPAs), off-balance sheet exposures, structured products and securitizations/assignments. • NBFCs with assets of |. 10 billion and above should be inspected comprehensively on an annual basis with an annual stress test carried out to ascertain their vulnerability”.

3.6 Our Suggestions on the RBI Working Group Report For a very long period, it has been argued that the most of the NBFCs are taking undue benefits due to regulatory arbitrage and this has placed serious concerns for RBI regarding ensuring and nurturing financial stability of the system. It is well understood, and one can appreciate the concerns of RBI regarding risk associated with a large number of un-registered/unregulated smaller entities, as their activities have a lot of interactions with low-income population and if something goes wrong, this has huge political implications. At the same time, RBI has amply appreciated the positive role played by NBFCs. In the last few years, the world over, concerns have been expressed regarding the functioning of ‘shadow banking’ and regulators are taking steps to rein their negative impacts. But in India, we do not have the kind of ‘shadow banks’, as discussed in the international arena (Sinha 2013). While these concerns are well founded and it is important to strengthen the regulatory environment for NBFCs, wherever required, this should not lead to a situation that retards their contributions of NBFCs to the economic growth. The pertinent question is then how do we move forward while creating a level playing field and simultaneously identifying risks at the incipient stage. More importantly, one has to recognize the role played by the NBFCs in financial inclusion and this is very important for India at this stage. With this objective in mind, we examine some of the recommendations of the RBI-WG Report and offer our suggestions on the same. • Establish a Permanent Finance Source for NBFCs: In the 1970s/1980s, when the economy needed investment in the housing sector, the RBI financed the NHB from its profits. Similarly, it contributed a good amount of money to promote agriculture and industry through the National Agricultural Credit (long-term operation) Fund and the National Industrial Credit (long-term operation) Fund. When credit flow to the priority sector fell short of the targeted amounts, the RBI created the Rural Infrastructure Development Fund (RIDF). Similarly, in promoting exports

44

•

•

•

•

3 Regulatory Developments and Prudential Norms

and export finance, the RBI created Exim Bank. Hence, the developmental role played by the RBI in providing credit to the needy sectors has paid rich dividends. On similar lines, the RBI could consider creating a facility to provide finance to select NBFCs in augmenting their capacity to lend to unbanked regions and people. The RBI may designate an institution, which will be responsible to disburse and monitor financial inclusion and credit to the targeted population. Given the present institutional mechanism in India, SIDBI is one such candidate that could be considered. As the Government of India (GOI) has already established Micro Units Development and Refinance Agency (MUDRA) Bank, that could also be considered. As MUDRA Bank has huge potential for financial inclusion, it is an optimal choice. Ease of Asset Securitization Norms for Support Sectors: The contribution of NBFCs in providing credit to the production sector is well recognized. In addition to direct production credit, they also lend money to supporting sectors, which help the productive sectors in terms of transport finance, infrastructure finance, etc. The RBI may consider easing of securitization of assets of these sectors, lower capital requirements and lower provisioning norms, on a par with similarly placed financial institutions. Encourage Priority Sector Lending by NBFCs: The share of owned funds as a part of total funds has gone up from 23% in fiscal 2005 to 26% in fiscal 2011. In this period, the use of public funds has gone down significantly. But the contribution of NBFCs in providing credit to the priority sectors has gone up, and to meet these credit requirements, NBFCs have borrowed from the banks. It is important to consider such NBFCs on a special footing, as they are different from those who lend predominantly to real estate or capital market transactions. Hence, the RBI may create a special window where the banks could lend to NBFCs, which in turn lend money to the priority sectors. In order to encourage this and bring greater transparency and checks, the external auditors of NBFCs could certify the money lent to priority sector by NBFCs and those who misuse the facility be punished heavily. Bring large NBFCs on a par with Banks on ALM Norms: NBFC-ND-SIs with assets of more than |1 billion and NBFC-Ds with deposits over |200 million have been asked to adhere to the asset–liability norms as prescribed by the RBI. Such NBFCs have to maintain a gap not exceeding 15% of their net cash outflows in the 1-month bucket. This would increase the cost of funds and is a challenging task when funds are drying up. This would no doubt push the cost of funds for borrowers. Earlier, the NBFCs had to maintain this amount in a 1-year time bucket. While we understand the liquidity concerns of risk management for NBFCs, this could be easily addressed by prescribing a particular level of liquidity coverage ratio. The RBI may even consider relaxing this 1-month time bucket in stages. This would also bring NBFCs of the above category on a par with banks. Include Investments in Liquid Funds for Computing Total Financial Assets: As NBFCs invest in liquid money market mutual funds, this component shall be included in the eligible liquid instruments, as available to other types of financial

3.6 Our Suggestions on the RBI Working Group Report

•

•

•

•

45

institutions. This facility will give them additional facility for investing their funds and also help in proper ALM. Allow Issue of Perpetual Bonds by NBFCs-D: The RBI has increased the CRAR for NBFCs-ND-SI from 12 to 15%, and to meet this higher capital requirement they were allowed to raise money through the issue of perpetual bonds. Recently, the RBI has increased the CRAR for NBFCs-D, also. If we analyse the health parameters of NBFCs-ND-SI and NBFCs-D, the latter category is one notch above the former. Hence, NBFCs-D may also be permitted to meet this higher capital requirement through the issue of perpetual bonds. Revisit CRAR Requirements for NBFCs: The RBI-WG has suggested that Tier 1 CRAR be raised to 12% from 10% for all NBFCs. The main argument to support this increase is that the banks have to adhere to CRR, SLR and priority sector obligations. But if we look at the health parameters, many NBFCs-D and NBFCsND-SI are in a better position than banks. Moreover, banks have risk weights for their borrowers and based on the risk weight, the capital charge varies. In order to bring a level playing field, either the CRAR for NBFCs may be kept at the old level, or the RBI may prescribe two or three categories of CRAR, each one determined by a set of health parameters, where the best one enjoys a lower CRAR and the value of CRAR increases with the decline in the health parameters. The ultimate solution lies in prescribing risk-weighted CRAR requirements based on the credit rating of the borrowers. In this context, the credit rating obtained from the rating agencies could be a good starting point. Prescribe a Calibrated Risk-Weighted Approach to CRAR for NBFCs: Since 1 April 2011, the RBI has prescribed that the total CRAR be increased from 12 to 15%, of which Tier 1 CRAR would be 10%. As discussed above, the RBIWG recommended that this Tier 1 CRAR be increased to 12%. Both the policy recommendations have deleterious effects on the cost of capital and would also increase the lending rates for the borrowers. While we agree that risk management principles must be given due recognition and any kind of systemic risk must be addressed comprehensively at the incipient stage itself, the RBI could consider a calibrated risk-weighted approach for NBFCs as it has prescribed for banks. If we go by the liability side classification of NBFCs, the risk weights for asset financing/SME business/financial inclusion/priority sector lending may be reduced to 50%, and for all others, risk weights may be at 100%. This would force NBFCs to adopt a risk-based culture in their business analytics and would also improve their risk-based performance. Rethink Reduction in Period for NPA Classification: The period for classifying loans as NPAs in case of NBFCs is 180/360 days. RBI-WG has suggested reducing this period. We feel this suggestion may not work. Major health parameters are at different levels for various segments of financial institutions, and bringing NBFCs on a par in terms of the period for classifying NPAs does not sound well. For any financial institution, attention should be paid towards specific features of the borrowers, collection method, etc., while fixing the period for classifying NPAs.

46

3 Regulatory Developments and Prudential Norms

Chart 3.2 New asset classification norms

It must also be recognized that many small borrowers have turned their business model to match the collection requirements. Hence, bringing down this requirement will significantly affect small business units, in particular. Chart 3.2 provides the revised asset classification norms. • Mandatory ratings may be waived for small NBFCs with balance sheet strength, up to a limit: NBFCs borrow money in general as working capital loans, and this money is used for onward lending. Currently, the rated AFCs are allowed to accept deposits. The upper limit of the deposits shall not exceed 4 times their net owned funds. The RBI-WG has suggested that this ceiling may be reduced to 2.5 times. However, the rationale for this recommendation is not well founded. The RBI-WG also suggested that the AFCs are not allowed to accept fresh deposits if the ceiling is already reached. It also suggested rating of AFCs. The 14 November 2014 circular of the RBI prescribed that NBFCs which are not rated cannot accept deposits. Hence, obtaining credit rating has become mandatory for all NBFCs. In general, the rating agencies consider the size of NBFCs, their business potential, etc. For many small NBFCs, getting ratings may be a costly affair. At the same time, the financial risk is to be duly recognized. Hence, it is worth examining whether small NBFCs can be allowed to borrow up to |100 million even without a rating, provided there is enough balance sheet strength. Furthermore, it has prescribed 1.5 times for all NBFCs. Given the demand for credit and other avenues available, this is very low. The RBI may consider prescribing a graduated quantum of borrowing based on a set of health parameters.

3.7 Regulatory Guidelines of the RBI (10 November 2014) The linkages between NBFCs and other segments of the financial sector have become quite prominent of late. In the aftermath of the 2008 Global Financial Crisis, concerns were raised in many quarters regarding the importance of appropriate regulations for the shadow banking sector. Compared with a number of countries, India was not

3.7 Regulatory Guidelines of the RBI (10 November 2014)

47

that affected, thanks to the prudential measures prescribed by the RBI from time to time. Taking cues from the Usha Thorat Working Group and the Committee on Comprehensive Financial Services for Small Businesses and Low-Income Households (chaired by Nachiket Mor), the RBI announced new regulations for NBFCs. A significant paradigm shift signalled in the Nachiket Mor Committee involves a move from entity-based regulation of NBFCs to activity-based regulation. A brief account of these latest set of measures is as follows2 : • The minimum NOF criterion for existing NBFCs, but was registered prior to April 1999, has been increased to |20 million. NBFCs were allowed to reach the required minimum level till March 2017. • In order to harmonize and strengthen deposit acceptance regulations for all NBFCsD, the credit rating was mandatory for existing unrated AFCs by 31 March 2016. The maximum limit for acceptance of deposits has been harmonized across the sector to 1.5 times NOF. The threshold for defining systemic significance for nondeposit taking NBFCs has been increased to |5 billion from the existing limit of |1 billion. • NBFCs-ND is classified into (i) NBFCs-ND with assets less than |5 billion and (ii) NBFCs-ND-SI with assets of |5 billion and above and regulations applied accordingly. NBFCs-ND is exempted from capital adequacy and credit concentration norms, while a leverage ratio of 7 has been introduced to them. • For NBFCs-ND-SI and NBFCs-D categories, strict prudential norms have been prescribed. Minimum Tier 1 capital requirement raised to 10% from earlier 7% in a phased manner (by the end of March 2017), asset classification norms from 180 to 90 days in a phased manner (by the end of March 2018) and in line with that of banks, along with an increase in provisioning requirement for standard assets to 0.40% in a phased manner (by March 2018). • The exemption given to AFCs from the prescribed credit concentration norms of 5% has been withdrawn with immediate effect. • Additional corporate governance standards and disclosure norms for NBFCs have been issued for NBFCs-D and NBFCs-ND. • NBFCs with assets of less than |5 billion will not be subject to prudential norms if they do not access public funds. Further, business regulations will not apply to those NBFCs without customer interface. • Assets of multiple NBFCs in a group will be aggregated to determine if such consolidation falls within the asset sizes of the two categories. Relevant regulations applicable to these two categories will be applicable to each of the NBFCs-ND within the group. • Reporting regime has been rationalized for NBFCs with asset size less than |5 billion. A brief sketch of the revised classification of NBFCs is depicted in Chart 3.3. Further, regulatory changes brought during the years 2014–15 and 2015–16 are shown in Table 3.1. 2 For

more details, see RBI website: www.rbi.org.in/scripts/NotificationUser.aspx?Id=9327.

48

3 Regulatory Developments and Prudential Norms

Chart 3.3 Revised NBFCs classification Table 3.1 Key changes in the NBFCs regulations (2014–16) 2014 July 25

NBFCs need to obtain a Global Intermediary Identification Number (GIIN)

August 5

(i) SCs/RCs need to invest a minimum 15% of Security Receipts (SRs) of each class/scheme issued by them on an ongoing basis till redemption of SRs (ii) Management fees need to be calculated and charged as a percentage of the minimum net asset value (NAV) specified by a credit rating agency (rather than a percentage of outstanding SRs at present) (iii) Asset Reconstruction Companies (ARCs) will also be considered as members of a JLF (iv) ARCs need to place the list of a suit filed against the accounts of wilful defaulters on their websites at quarterly intervals

August 12

All NBFCs-ND with asset size of |10 billion and above will be allowed to participate in the interest rate future market as trading members

September 25

NBFCs can use the ratings of SMERA for rating their fixed deposits

November 10

Threshold for defining systemic significance for NBFCs-ND increased to |5 billion. Also, stricter prudential norms are prescribed for NBFCs-ND-SI/NBFCs-D

November 10

Due to the Factoring Regulation Act, 2011, the principal business criteria for NBFC factors revised to 50:50 from 75:75

2015 January 2

Revised due diligence process/updation for KYC compliance for various categories of customers, allowing third-party verification (continued)

3.7 Regulatory Guidelines of the RBI (10 November 2014)

49

Table 3.1 (continued) February 6

Minimum investment grade for long-term fixed deposit products provided by Brickwork Ratings India Pvt. Ltd. is treated equivalent to FBBB

February 6

It is mandatory for credit institutions to become members of all CICs

February 20

Guidelines on private placements were revised with the issue of non-convertible debentures (NCDs) classified into: (a) a subscription of |20,000–|10 million per investor with a maximum of 200 subscribers in a financial year and the issue being fully secured, and (b) a minimum subscription of |10 million and above with no limit on the number of subscribers and the need for the creation of security should be as approved by their boards

April 8

For NBFC-MFIs, the limit on the total indebtedness of a borrower, excluding educational/medical expenses, raised to |100,000 from |50,000. Loans disbursed to a borrower with a rural household annual income not exceeding |100,000 or urban and semi-urban household income not exceeding |160,000 will be included as qualifying ssets

April 10

NBFCs lending against collateral of listed shares need to maintain an LTV ratio of 50%, accept only Group 1 securities (as specified by SEBI) as collateral for loans of value more than |. 5 million where the lending is done for investment in the capital market

April 10

Application of enhanced corporate governance guidelines for NBFCs-ND-SIs and deposit taking NBFCs

April 30

Decision to dispense with the requirement of prior approval from the Reserve Bank for NBFCs to distribute mutual fund products

May 14

Amendment of directions issued to infrastructure debt funds (IDFs) to allow entry of IDF-NBFCs into sectors where there is no presence of a project authority. Risk weight as applicable to bonds held by IDF-NBFCs and assets of infrastructure finance companies will be applicable to all NBFCs

July 2

For determination of the concentration of credit/investment, investments of NBFC in the shares of its subsidiaries/companies in the same group are excluded to the extent they have been reduced from owned funds for calculation of NOF

July 9

NBFCs need prior approval of the Reserve Bank of India in cases of acquisition/transfer of control of NBFCs

July 23

Guidelines on early recognition of financial distress, prompt steps for resolution and fair recovery for lenders: a framework for revitalizing distressed assets, review of the guidelines on JLF and corrective action plans as applicable to banks were made, mutatis mutandis, applicable to NBFCs

July 30

Guidelines on restructuring of advances as applicable to banks were made, mutatis mutandis, applicable to NBFCs

October 29

Modifications in guidelines on early recognition of financial distress, prompt steps for resolution and fair recovery for lenders: a framework for revitalizing distressed assets in the economy, review of guidelines on JLF and corrective action plans relevant to banks were made, mutatis mutandis, applicable to NBFCs

November 26

The limit of loan issued by NBFC-MFIs with a tenure of not less than 24 months was increased to |30,000 from |15,000 (continued)

50

3 Regulatory Developments and Prudential Norms

Table 3.1 (continued) 2016 February 18

Prohibition of NBFCs from acting as Point of Presence (PoP) under the PFRDA’s National Pension System NBFC factors were given clarifications/instructions to discourage regulatory arbitrage between NBFC factors and banks The threshold for fraud reporting by NBFCs to the Central Fraud Monitoring Cell increased to |10 million from |2.5 million

March 10

Review of risk weights assigned to exposures of NBFCs to domestic sovereigns or claims guaranteed by them

April 7

Concentration of credit/investment norms would not apply to an NBFC-NDSI not accessing public funds either directly or indirectly and not issuing guarantees

April 13

General permission for NBFC-MFIs to act as channelizing agents for distribution of loans under special schemes of central/state government agencies exempting such loans from the qualifying asset criteria

April 21

General permission for IDF-NBFCs to raise funds through shorter tenor bonds and CPs from the domestic market to the extent of up to 10% of their total outstanding borrowing

May 26

Guidelines on SDR mechanism, a framework to revitalize distressed assets and revisions to the guidelines on restructuring as applicable to banks were made, mutatis mutandis, applicable to NBFCs

June 2

Guidelines on financing of loans applicable to banks were extended to NBFCs

June 17

Introduction of a simplified process of registration of NBFCs

Source RBI Annual Reports, various issues

From the above, it is clear that additional regulations were proposed to strengthen the financial position of NBFCs and there was some relaxation in the borrowing powers of NBFCs. During 2015–16, RBI focused mainly on strengthening the harmonization process across NBFCs and banks and tried to move towards activity-based regulation. In particular, the following activities were focused: (i) early recognition of financial distress, (ii) corrective steps for resolution and fair recovery for lenders, including guidelines on the formation of JLF and corrective action plan and (iii) factoring activities by banks and NBFC factors. A new category of NBFC, namely NBFCAA, was proposed. Further, a consultation paper was released in order to design a suitable regulatory framework for P2P lending.

3.8 NBFC-Account Aggregator “At present, financial asset holders such as holders of savings bank deposits, fixed deposits, mutual funds and insurance policies get a scattered view of their financial asset holdings if the entities with whom these accounts are held fall under the

3.8 NBFC-Account Aggregator

51

purview of different financial sector regulators. This gap will be filled by account aggregators who will provide information on various accounts held by a customer in a consolidated, organized and retrievable manner. The option to avail the services of an account aggregator by a customer will be purely voluntary. The RBI will regulate to ensure that the nature and terms of its services conform to prescribed standards. As per these guidelines, the business of an account aggregator will be entirely driven by information technology. The account aggregator will not support any transaction in financial assets by its customers. The account aggregator will not undertake any business other than the business of account aggregation. However, deployment of investible surplus by the aggregator in instruments, not for trading, will be permitted. Pricing of services will be as per the board-approved policy of the account aggregator” (RBI Annual Report 2016).

3.9 Peer-to-Peer Lending The RBI has also released a consultation paper on ‘peer-to-peer (P2P) lending’. “P2P is an innovative form of crowd-funding with financial returns. It involves the use of an online platform to bring lenders and borrowers together and help in mobilizing unsecured finance. The borrower can either be an individual or a business requiring a loan. The platform enables a preliminary assessment of the borrower’s creditworthiness and collection of loan repayments. Accordingly, a fee is paid to the platform by both borrowers and lenders. Interest rates range from a flat interest rate fixed by the platform to dynamic interest rates as agreed upon by borrowers and lenders using a cost-plus model (operational costs plus a margin for the platform and returns for lenders” (RBI Annual Report 2016). P2P has the advantage of lower rate of interest than the rates offered by money lenders/unorganized sector. The lenders benefit by getting higher returns than the return from a savings account or from any other investment. It is interesting to note that in Japan and Israel, the P2P lending platforms are banned. In countries like France, Germany and Italy, they are regulated as banks. In China and South Korea, they are exempted from any regulation. Despite, there are currently many online P2P lending platforms and they grow at a rapid pace. Moreover, during 2015–16, a simplified and rationalized process of issuing Certificates of Registration (CoRs) for NBFCs was followed. As per the simplified system, only 8 instead of 45 documents need to be submitted for CoR. In addition, for the purpose of CoR, the NBFCs were divided into two categories, namely Type I and Type II. A fast-track application of Type I NBFCs (which do not access public funds and do not have customer interface) was introduced. During 2016–17, the RBI had proposed to review the role of statutory auditors in the certification process in order to have a wider supervisory oversight of a large number of small NBFCs. The initiation that the process of leveraging IT for processing of necessary approvals by the Reserve Bank has been taken forward during the year. Further, through enhanced supervision, the compliance of NBFCs with the

52

3 Regulatory Developments and Prudential Norms

Fair Practices Code is improved. The RBI also planned to develop a formal PCA framework for NBFCs. Last but not least, there has been certain step initiated towards the liberalization of foreign investment in the NBFC sector. The harmonization of provisions of the regulations for foreign direct investment (FDI) in an NBFC with the RBI-NBFC directions is finally gaining some momentum. The finance minister in his budget speech on 29 February 2016 announced the government’s intention to permit FDI in all financial activities which are regulated by an Indian regulator under the automatic route. This will help the NBFCs to undertake investment activities without the Foreign Investment Promotion Board’s (FIPB) approval.

3.10 Summing Up According to the latest regulation, the RBI is using the dividing line of |. 5 billion. All NBFCs above this threshold limit are subject to CRAR, prudential and income recognition norms. In view of this, NBFCs having below |. 5 billion as capital may go for merger and acquisitions. While, on the one hand, this would reduce the number of below line NBFCs, small NBFCs may continue. Care is needed too that these small NBFCs shall not create any systematic risks. At the same, NBFCs having capital of |. 5 billion and above may be given a number of benefits, as explained here so that they are on sound and transparent rating. A time has come where the RBI has to position measures to strengthen in meeting fund requirements of NBFCs. This would not only benefit NBFCs having capital above |. 5 billion, but also reduce the cost of borrowings, while in turn would help the borrowers from this NBFC sector, who are not getting any continuous financial assistance from banks. If we analyse the performance of NBFCs, there are many small-/medium-sized NBFCs which are doing business well and have strong balance sheets, there are some big NBFCs who are not doing well, and they pose some amount of risk to the system. Hence in addition to the size of the NBFCs, RBI may consider some of the balance sheet ratios, which truly exhibit the strength of the NBFCs, and these strong NBFCs may be allowed to enjoy the benefits. By this process, there is a clear ‘stick and carrot’ approach. The contribution of NBFCs in providing credit to the production sector is well recognized. In addition to the direct production credit, they also lend money to supporting sectors, which help the productive sectors, in terms of transport finance, infrastructure finance, etc. RBI may consider easing of securitization of assets of these sectors, lower capital requirements and lower provisioning norms, on a par with similarly placed financial institutions.

Appendix

53

Appendix Regulating NBFCs can be traced back to the late 1950s and early 1960s when the country witnessed several bank failures resulting in loss to depositor. At that point of time, although NBFCs were not as important as banks, RBI realized the potential threat from those NBFCs, which were collecting public deposits, to cause depositor run. Therefore, RBI initiated regulating them. The objectives of regulating NBFCs were to (a) shield depositor from any loss in case an NBFC fails, (b) ensure effectiveness of credit or monetary policy and (c) promote the NBFC sector on safe and sound lines. Thus, the Banking Laws (Miscellaneous Provisions) Act, 1963, was introduced to incorporate a new chapter (i.e., Chapter III B) in the Reserve Bank of India Act, 1934, to regulate these companies. However, with a view to enunciating appropriate laws, the regulator appointed from time to time various committees to study the role, functions and operations of NBFCs in detail and recommend suitable policy measures for their growth on desirable lines. The committees which directly or indirectly contributed to building the NBFC regulatory architecture over time are listed below: i. Bhabatosh Datta Study Group (1971).3 ii. James Raj Study Group (1974).4 iii. Sukhamoy Chakravarty Committee on Working of the Indian Monetary System (1985).5 iv. N. Vaghul Working Group on the Money Market (1987).6 v. M. Narasimham High-level Committee on the Financial System (1991).7 vi. Joint Parliamentary Committee to investigate irregularities in the Securities Transactions (1992).8 3 The

Study Group set up to examine the role and operations of NBFCs recommended that: (i) there should be two classifications of NBFCs, namely ‘approved’ (i.e., those which satisfy certain additional requirements such as adequate amount of capital, reserves, liquid assets, etc.) and ‘nonapproved’; and (ii) the regulation need to be centred primarily on the ‘approved’. 4 The Study Group’s suggested regulatory framework aimed at keeping the magnitude of deposits accepted by NBFCs within reasonable limits and ensuring that they were in conformity with the objectives of monetary and credit policy. 5 The committee’s recommendation for introduction of a system of licensing for NBFCs is basically aimed to protect the interests of depositors. 6 The working group recommended against allowing NBFCs into call money market. 7 The committee underscored the growing importance of NBFCs in the financial intermediation process and their recourse to borrowing. It outlined a framework for streamlining their functioning which included, in addition to the existing requirements of gearing and liquidity ratios, norms relating to capital adequacy, debt-equity ratio, credit concentration ratio, adherence to sound accounting practices, uniform disclosure requirements and asset valuation. The committee also argued that the supervision of these institutions should be done by an agency to be set up for this purpose under the aegis of RBI. For these purposes, a suitable legislation need to be introduced for ensuring sound and healthy functioning of NBFCs and also for safeguarding depositors’ interests. 8 The committee recommended for strengthening the legislative framework and vesting RBI with more powers to effectively regulate NBFCs.

54

3 Regulatory Developments and Prudential Norms

vii. Shah Working Group on Financial Companies (1992).9 viii. Khanna Committee (1995) for designing a supervisory framework for NBFCs (Khanna Committee).10 ix. M. Narasimham Committee on Banking Sector Reforms (1998).11 x. Y.V. Reddy Working Group on Money Supply: Analytics and Methodology of Compilation (1998).12 xi. C. M. Vasudev Task Force on NBFCs (1998).13

9 The

wide-ranging recommendations by the working group are considered as a watershed development in the NBFC sector which laid down a strong plinth for constructing the future regulatory structure of the sector. Subsequently, many new legislations were brought in. 10 The committee recommended for off-site surveillance and on-site examination system for NBFCs based on their asset size and the nature of business. It also recommended for bringing in more transparency in their financial statements. 11 The committee recommended that (a) mergers between banks and between banks and DFIs and NBFCs need to be based on synergies and locational and business specific complementarities of the concerned institutions; (b) the required statutory minimum net worth of NBFCs for registration need to be progressively enhanced to |. 2 crore which is permissible now under the statute and that in the first instance; it may be raised to | 50 lakh; (c) no deposit insurance cover for deposits with NBFCs to be provided; and (d) an integrated system of regulation and supervision be put in place to regulate and supervise the activities of banks, financial institutions and NBFCs. 12 The group proposed a new measure of liquidity aggregate incorporating NBFCs with public deposits of |. 0.20 billion and above. 13 The Task Force recommended for (i) changing the existing legislative and regulatory framework for NBFCs to address the rising number of defaulting NBFCs and need for a quick redressal system; (ii) extension period for attaining minimum NOF beyond 3 years (January 2000) needs to be made conditional on adequate steps taken by the concerned NBFCs, and the minimum prescribed NOF of |. 25 lakh needs to be revised upward; (iii) RBI needs to draw up a time-bound programme for disposal of applications for registering NBFCs and provides the registration details to concerned states; (iv) higher CRAR of 15% for NBFCs seeking public deposits without credit rating as against existing 12% for rated NBFCs prescribed by the RBI; (v) RBI need to prescribe the ceilings for exposures to real estate sector and investment in capital market, especially unquoted shares; (vi) RBI may stipulate that 25% of reserves of NBFCs may be invested in marketable securities in addition to SLR securities already held by them; (vii) ceilings may be prescribed for public deposits with respect of different categories of NBFCs as follows: (a) NBFC with NOF less than |25 lakh—no access to public deposits, (b) EL/HP Company without credit rating—1.5 times NOF or |. 10 crore whichever is lower, subject to 15% CRAR, (c) EL/HP Company with investment grade credit rating—4 times NOF and (d) Loan/Investment Cos with investment grade credit rating—1.5 times NOF (higher CRAR of 15%); (viii) a suitable ratio between secured and unsecured deposits for NBFCs need to be preceded by measures to ease the flow of bank credit to them; (ix) Increased liquid asset ratio from existing 12.5 to 25% of public deposit in a phased manner and the statutory provision

Appendix

55

xii. RBI Discussion Paper on Harmonization of the Role and Operations of DFIs and Banks (2004).14 xiii. Usha Thorat Working Group on the Issues and Concerns in the NBFC Sector (2011) (Table 3.2).15

needs to be given to unsecured depositors first charge on liquid assets; (x) RBI needs to appoint the depositors’ grievance redressal authority with specified territorial jurisdiction with the help of the office of the Banking Ombudsman available in several states; (xi) It is necessary to set up a separate instrumentality for regulation and supervision of NBFCs under the aegis of RBI and entrusted under one executive director/supervised by a deputy governor; (xii) strengthening the off-site surveillance mechanism to identify/control NPAs; developing a sensitive market intelligence system to trigger on-site inspection, to be followed by appropriate regulatory response; (xiii) deposits accepted by unregistered NBFCs need to be considered as a cognizable offence; state governments should set up special investigation wings for enforcing this provisions; and (xiv) unauthorized deposit taking by unincorporated financial intermediaries needs also to be considered as a cognizable offence. State governments should quickly enact legislation on the lines of the Tamil Nadu legislation. 14 The paper noted that (i) all NBFCs (other than RNBCs) with assets of |. 500 crore or above should be treated as a separate category of NBFCs; (ii) DFIs, which are established as companies should be regulated and supervised as a subset of NBFCs and on a footing different from what is applicable to large-sized NBFCs; and (iii) RBI should take initiatives to collect all relevant information to the systemic concerns pertaining to large-sized non-PD companies at regular intervals. This initiative may be followed up with more rigorous measures to prevent any threat to the systemic stability. 15 The working group recommended various measures to ensure both the resilience of the NBFC sector and contain risks emanating from the sector in the context of overall financial stability. Broadly, they are on the following issues: (i) entry-point norms, principal business criteria, multiple and captive NBFCs; (ii) corporate governance including disclosures; (iii) liquidity management; and (iv) prudential regulation including capital adequacy, asset provisioning, risk weights for certain sensitive exposures and restrictions on deposit acceptance. A draft guidelines were prepared and kept in public domain for comments in December 2012 based on the recommendations of the working group and the subsequent extensive deliberations with all the stakeholders.

56

3 Regulatory Developments and Prudential Norms

Table 3.2 Chronological account of regulatory developments in the NBFC sector 1993 Introduction of a scheme of registration for NBFCs having NOF of |. 50 lakh and above 1994 Issuance of guidelines on prudential norms so as to regulate the assets side of the balance sheet of NBFCs Under the 1993 scheme, the NBFCs registered with RBI should adhere to the prudential norms from March 1995. But most of them failed to comply with the norms and also failed to submit their half yearly returns, thus defeating the very purpose of registration. The reason was that these measures were not be given statutory backing at that time. In order to bridge this regulatory gap and in pursuance of the recommendations of the Shah Working Group in January 1997, the government issued an ordinance effecting comprehensive changes in the provisions of the Reserve Bank of India Act, 1934. This was subsequently replaced by the Reserve Bank of India (Amendment) Act in March 1997 1997 The salient features of the amended provisions, based on the recommendations of the Shah Committee, pertained to: i. Compulsory registration of NBFCs and a minimum NOF of |. 25 lakh as entry-point norm ii. Maintaining certain percentage of liquid assets in the form of unencumbered approved securities iii. Creation of reserve fund and transfer thereto every year an amount not less than 20% of net profit iv. RBI’s role in determining the policy and issuing of directions on prudential norms v. Vesting RBI with the powers to: (a) Giving directions to NBFCs regarding compliance with the prudential norms and to NBFCs and their auditors on matters relating to balance sheet and undertake special audit and impose penalty on erring auditors (c) Prohibiting NBFCs from accepting deposits by violating the provisions of the RBI Act and direct them not to alienate their assets (d) File winding up petition against NBFCs for violations of the provision of the Act/directions (e) Impose penalty directly on NBFCs for non-compliance with the provisions of the Act vi. Empowering the Company Law Board to direct a defaulting NBFC to repay any deposits 1997 i. Department of Non-Banking Supervision was formed by segregating FCW from Department of Banking Supervision for focused attention to the supervision of NBFCs by 16 regional offices ii. The Reserve Bank of India (Amendment) Act was passed amending Chapters lll B, lll C and V of RBI Act, 1934 iii. Reserve Bank of India (Non-Banking Financial Companies) Returns Specifications 1997 was issued 1998 (i) NBFCs classified into the following three categories for the purposes of regulation: (i) those accepting public deposits, (ii) those which do not accept public deposits but are engaged in the financial business, and (iii) core investment companies which hold at least 90% of their assets as investments in the securities of their group/holding/subsidiary companies (ii) NBFCs accepting public deposits were subject to more rigorous regulations than those not accepting public deposits (iii) For new NBFCs (incorporated after April 20, 1999), the minimum NOF was raised to |. 2 crore (iv) The liquidity requirement for NBFCs was enhanced. Accordingly, loan and investment companies for which liquidity ratio was earlier 5.0% were directed to increase the same to 7.5 and 10.0% of their deposits in government and other approved securities, effective January 1 and April 1, 1998, respectively (v) For other NBFCs, the percentage of assets to be maintained by them as statutory reserves increased to 12.5% (vi) In order to ensure that NBFCs can have recourse to such liquid assets in emergency, the custody of these assets with designated commercial banks was prescribed (vii) The capital adequacy ratio was also raised in a phased manner to 10.0 and 12.0% by end-March 1998 and 1999, respectively Regulations over NBFCs accepting public deposits (NBFCs-D) RBI issued directions relating to acceptance of public deposits prescribing (continued)

Appendix

57

Table 3.2 (continued) (a) The quantum of public deposits (b) The period of deposits which should not be less than 12 months and more than 60 months (c) A ceiling of 16% for the rate of interest payable on such deposits (d) A cap on the brokerage fees and other expenses at 2 and 0.5% of the deposits, respectively (e) The contents of the application forms as well as the advertisement for soliciting deposits (f) NBFCs need to comply with all the prudential norms relating to income recognition, asset classification, accounting standards, provisioning for bad debts, capital adequacy, credit/investment concentration norms, etc. (g) The capital adequacy ratio was fixed at 12% and above in accordance with the eligibility criteria for accepting public deposits (h) The credit and investment concentration norms were fixed at 15 and 25% of the owned funds respectively, depending on whether the exposure is to a single borrower to a borrower group. The totality of loans and investment was subject to a ceiling of 25 and 40% of the owned fund, respectively, depending on whether the exposure is to a single party or to an industry group Regulations over NBFCs not accepting public deposits (NBFCs-ND) (a) These NBFCs should be regulated in a limited manner, and they were exempted from the regulations on interest rates, period as well as the ceiling on quantum of borrowings (b) The ceiling on the aforesaid factors for NBFCs-D expected to act as a benchmark for NBFCs-ND (c) However, prudential norms having a bearing on the disclosure of true and fair picture of their financial health made applicable to ensure transparency in the financial statements to these companies, except those relating to capital adequacy and credit concentration norms 1999 RBI defined ‘principal business.’ Accordingly, a company will be treated as an NBFC if its financial assets are more than 50% of total assets (netted off against intangible assets) and income from financial assets is more than 50% of the gross income. Both these criteria are required to be fulfilled as the determinant factor for ‘principal business’ of a company 2000 On the lines of scheduled commercial banks, all NBFCs having asset size of |. 50 crore or above were advised to have compulsory internal audit system and also constitute an audit committee from among the members of their board of directors 2001 The concept of asset–liability management was introduced in 2001 for all NBFCs with asset base of |. 100 crore or holding public deposits of |. 20 crore or more 2003 As part of implementation of the recommendation of the Working Group on Redesigning of Financial Statements of NBFCs, additional schedule to balance sheet of NBFCs was stipulated for all NBFCs 2004 NBFCs-ND was advised that they would require |. 2 crore NOF before applying for permission to accept public deposits 2005 The concept of corporate governance was introduced with directions to rotate partner of statutory auditors after 3 years 2006 i. Guidelines on Fair Practices Code issued to NBFCs ii. Systemic significance of the sector recognized iii. NBFCs with asset size of |. 100 crore and above classified as systemically important (SI) companies; iv. Capital adequacy requirements and credit concentration norms introduced (continued)

58

3 Regulatory Developments and Prudential Norms

Table 3.2 (continued) 2007 i. The need for differential regulation was recognized for deposit taking and non-deposit taking companies, and separate prudential norms were issued for them in February 2007 ii. Submission of an annual statement of capital funds, risk asset ratio, etc., as at end-March every year stipulated for NBFCs-ND-SI 2008 i. Guidelines for NBFC-ND-SI as regards capital adequacy, liquidity and disclosure norms issued: (a) Increase in capital adequacy to 12% w.e.f. 31 March 2010 and 15% w.e.f. March 31, 2011 (b) Introduction of ALM reporting and disclosure norms for NBFC-ND-SI ii. NBFCs with asset size of |. 50 crore and above but less than |. 100 crore were advised to submit online, a quarterly return on important financial parameters 2011 i. Provisioning requirement for standard assets—a general provision at 0.25% of the outstanding standard assets introduced ii. CRAR requirement of NBFCs-D increased to 15% from the extant 12% w.e.f. 31 March 2012 iii. NBFCs were prohibited from contributing capital to any partnership firm or to be partners in partnership firms iv. Contribution made by the group entities in an insurance JV along with the NBFC brought within the ceiling of ‘not more than 50% of the paid up equity capital of the insurance JV’ v. Eligibility parameters for NBFCs as Sponsors of IDF-MFs announced by inserting a new chapter, i.e., Chapter VI B to the MF Regulations. These included: The NBFC should have a minimum NOF of |. 300 crore and CRAR of 15% Its net NPAs should be less than 3% of net advances It should have been in existence for at least 5 years It should be earning profits for the last 3 years, and its performance should be satisfactory The CRAR of the NBFC post-investment in the IDF-MF should not be less than the regulatory minimum prescribed for it (f) The NBFC should continue to maintain the required level of NOF after accounting for investment in the proposed IDF and (g) There should be no supervisory concerns with respect to the NBFC

(a) (b) (c) (d) (e)

i. Eligibility parameters for IFCs setting up IDF-NBFCs announced, and these included: (a) Only NBFC-IFCs can sponsor IDF-NBFC with prior approval of RBI and subject to the following conditions (b) Sponsor IFCs would be allowed to contribute a maximum of 49% to the equity of the IDF-NBFCs with a minimum equity holding of 30% of the equity of IDF-NBFCs (c) Post-investment in the IDF-NBFC, the sponsor NBFC-IFC must maintain minimum CRAR and NOF prescribed for IFCs (d) There are no supervisory concerns with respect to the IFC ii. The off-balance sheet regulatory framework expanded in order to introduce greater granularity in the risk weights and credit conversion factors for different types of off-balance sheet items 2011–12 Working Group to Examine Issues Relating to Gold Loans: There has been a significant increase in loans by non-banking financial companies (NBFCs) against gold in the recent period. There are also complaints that some NBFCs are not scrupulously following the proper documentation process and KYC norms, among others, in order to quickly dispose of the cases relating to gold loans. Gold imports have also increased sharply, raising macroeconomic concerns The major terms of reference of the group were: i. To assess the trends in demand for gold loans and how they have influenced gold imports ii. To analyse the implications of gold imports for external and financial stability iii. To study the trends in gold prices and to examine whether NBFCs that extend gold loans play any role in influencing the price of gold iv. To examine the sources of funds of NBFCs for gold loans, especially their borrowings from the banking system v. To examine the current practices of NBFCs involved in lending against the collateral of gold The working group submitted its report in August 2012 (continued)

Appendix

59

Table 3.2 (continued) 2012–13 (1) During 2012–13, a new category of NBFC, viz. non-banking financial company-factors, was created and a regulatory framework in the form of entry-point capital and prudential regulations was placed on them (2) NBFCs lending against collateral of gold jewellery were advised to maintain a loan-to-value (LTV) ratio not exceeding 60% and to disclose in their balance sheets the percentage of such loans to their total assets. If the loans extended by a NBFC comprise 50% or more of its financial assets, it shall maintain a minimum Tier l capital of 12% by 1 April 2014. All NBFCs were advised that no advances should be granted by them for purchase of gold in any form, including primary gold, gold bullion, gold jewellery, gold coins, units of gold exchange-traded funds (ETFs) and units of gold mutual funds (3) The recommendations of the Working Group to Study the Issues Related to Gold Imports and gold loans NBFCs in India set up by the Reserve Bank and relating to NBFCs lending against the collateral of gold jewellery were broadly accepted by the Reserve Bank, and guidelines were issued covering inter alia aspects such as appropriate infrastructure for storage of gold ornaments, prior approval of the Reserve Bank for opening branches in excess of 1000 in number, standardization of value of gold in arriving at LTV ratio, verification of the ownership of gold jewellery and process and procedures for auction of gold jewellery Revisions to Guidelines on Fair Practices Code for NBFCs (4) The Fair Practices Code has been revised to include sector specific features to enhance transparency and fair practices relating to microlending and lending against collateral of gold in the light of operational issues surrounding these activities. Margin caps for Non-Banking Financial Company-Micro Finance Institutions (NBFCMFI) revised (5) Given the problems being faced by NBFCs-MFI, the margin cap for lending by NBFCs-MFI irrespective of their size stands at 12% till 31 March 2014. With effect from 1 April 2014, margin cap as defined by the Report of the Sub-Committee of the Central Board of Directors of Reserve Bank of India to Study Issues and Concerns in MFI Sector (Chairman: Shri Y.H. Malegam) shall not exceed 10 % for large MFIs (loans portfolios exceeding 1 billion) and 12% for others Guidelines issued for Core Investment Companies Venturing into Insurance Business (6) In view of their unique business model, a separate set of guidelines were issued for core investment companies (CICs), registered with the Reserve Bank, for their entry into insurance business. While the eligibility criteria, in general, are similar to that for other NBFCs, no ceiling has been stipulated for CICs in their investment in an insurance joint venture. Further, it was clarified that CICs cannot undertake insurance agency business. The guidelines include, inter alia, conditions such as owned funds not being less than |. 5 billion and the level of NPAs not being more than 1 % of the total advances. The CIC should have registered net profit continuously for three consecutive years. The track record of the performance of the subsidiaries, if any, of the concerned CIC should be satisfactory. Directions issued to CICs regarding overseas investment (7) A separate set of regulations have been placed on overseas investments by CICs. All CICs require prior approval and registration with the Reserve Bank for investing in joint ventures/ subsidiaries/representative offices overseas in the financial sector. The total overseas investment should not exceed 400% of the owned funds of the CIC out of which overseas investment in financial sector should not exceed 200% Guidelines issued with respect to private placement by NBFCs (8) Guidelines were issued with regard to private placement of non-convertible debentures by NBFCs after certain adverse features came to the notice of the Reserve Bank. The guidelines aim to bring NBFCs at par with other financial entities as far as private placement is concerned by restricting the maximum number of subscribers. NBFCs were also required to put in place a board approved policy by 30 September 2013 for resource planning which, inter alia, would cover the planning horizon and the periodicity of private placement. The minimum subscription amount for a single investor has been capped at |. 2.5 million and in multiples of |. 1 million thereafter (continued)

60

3 Regulatory Developments and Prudential Norms

Table 3.2 (continued) 2013–14 1. The minimum net owned fund (NOF) criterion for existing NBFCs (those registered prior to April 1999) has been increased to |. 20 million. NBFCs have been allowed till March 2017 to achieve the required minimum levels 2. In order to harmonize and strengthen deposit acceptance regulations across all deposit taking NBFCs (NBFCs-D), credit rating has been made compulsory for existing unrated asset finance companies (AFCs) by 31 March 2016. Maximum limit for acceptance of deposits has been harmonized across the sector to 1.5 times of NOF 3. In view of the overall increase in the growth of the NBFC sector, the threshold for defining systemic significance for non-deposit taking NBFCs has been revised to |. 5 billion from the existing limit of |. 1 billion. Non-deposit taking NBFCs shall henceforth be categorized into two broad categories: NBFCs-ND (those with assets less than |. 5 billion) and NBFCs-ND-SI (those with assets of |. 5 billion and above—deemed as systemically important), and regulations will be applied accordingly. NBFCs-ND will be exempt from capital adequacy and credit concentration norms, while a leverage ratio of 7 has been introduced for them 4. For NBFCs-ND-SI and all NBFCs-D categories, tighter prudential norms have been prescribed—minimum Tier I capital requirement raised to 10% (from earlier 7% in a phased manner by end of March 2017), asset classification norms (from 180 days to 90 days in a phased manner by the end of March 2018) in line with that of banks and increase in provisioning requirement for standard assets to 0.40 % in a phased manner by March 2018. Exemption provided to AFCs from the prescribed credit concentration norms of 5% has been withdrawn with immediate effect. Additional corporate governance standards and disclosure norms for NBFCs have been issued for NBFCs-D and NBFCs-ND 5. NBFCs with assets of less than |. 5 billion shall not be subjected to prudential norms if they are not accessing public funds, and those not having customer interface will not be subjected to conduct of business regulations 6. Assets of multiple NBFCs in a group shall be aggregated to determine if such consolidation falls within the asset sizes of the two categories. Regulations as applicable to the two categories will be applicable to each of the NBFC-ND within the group. Reporting regime has been rationalized with only an annual return prescribed for NBFCs of assets size less than |. 5 billion Sources Chapter III Policy Environment in RBI’s “Report on Trend and Progress of Banking in India 2012–13” available at https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/03RTP211113C.pdf Chapter II: Financial Institutions: Developments and Stability in RBI’s Financial Stability Report (Including Trend and Progress of Banking in India 2013–14)” December 2014 available at https://rbidocs.rbi.org.in/rdocs/Publications/ PDFs/FSR29122014_FL.pdf Chapter III Financial Sector Regulation and Infrastructure in RBI’s “Financial Stability Report (Including Trend and Progress of Banking in India 2013–14)” December 2014 available at https://rbidocs.rbi.org.in/rdocs/Publications/ PDFs/7FISEREI241214.pdf RBI’s Working Group on the Issues and Concerns in the NBFC Sector: Report and Recommendations, August 2011 available at https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/FRWS250811.pdf Chapter IV Regulation, Supervision and Financial Stability in “RESERVE BANK OF INDIA ANNUAL REPORT 2015–16” available at https://rbidocs.rbi.org.in/rdocs/AnnualReport/PDFs/ 0RBIAR2016CD93589EC2C4467793892C79FD05555D.PDF Chronology of Major Policy Announcements: July 2014 to July 2015, available at https://rbidocs.rbi.org.in/rdocs/ AnnualReport/PDFs/09ANN06F4B30A61F54A8EBCEB33FFEAE0F937.PDF Karunagaran, A. (2011), “Inter-connectedness of Banks and NBFCs in India: Issues and Policy Implications”, RBI Working Paper Series No. 21/2011 available at https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/21WPN020112. PDF Chapter VI: Non-Banking Financial Institutions in RBI’s “REPORT ON TREND AND PROGRESS OF BANKING IN INDIA 2011-12”, available at https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/0TPB021112FLS.pdf RBI’s Notification to all ABFCs excluding RNBCS (Ref: RBI/2011–12/268 DNBS.PD.CC.No.249 /03.02.089/2011–12 November 21, 2011), available at https://rbidocs.rbi.org.in/rdocs/Notification/PDFs/ LDD21111CI.pdf Master Circular—Bank Finance to Non-Banking Financial Companies (NBFCs)(Ref: RBI/2015–16/36 DBR.BP.BC.No.5/21.04.172/2015–16 July 1, 2015), available at https://rbidocs.rbi.org.in/rdocs/notification/PDFs/ 36NB47BE452AB5244F56B2C77A72119DF392.PDF

Chapter 4

Acceptability of NBFCs to the Public

Although the origin of NBFCs could be traced back to early 1950s, they started their journey in the 1960s by covering both savers and investors who were not adequately covered by the formal banking sector, especially in the rural and semi-urban sectors. In those years, they used to collect deposits from investors and provided vehicle and gold loans for the Small and Medium Enterprises. They also used to work out leasing deals for big industrial houses. This journey continued in 1980s and 1990s and brought a huge number of savers and investors due to their friendly reputations. Although the NBFCs look like banks, they are not allowed to take demand deposits and issue cheques to customers. Further, the deposits with NBFCs are not insured by Deposit Insurance and Credit Guarantee Corporation (DICGC). However, the NBFC sector has witnessed significant growth over the years and emerged as a systematically key element of the financial system. Indeed, it is evident in India that with the development of NBFCs segment, it has challenged the other segments of the financial system. It is not an exaggeration that the banking system in India has imbibed a number of activities by looking into those of NBFCs including offering products at competitive prices and introduction of flexible timings. Gold loan and commercial vehicle loan are other clear examples. In a number of innovative ways, NBFCs started lending to rural and semi-urban areas which later copied by the banks. The NBFCs are successful because they have better product lines, costeffectiveness, wider and effective outreach, strong risk handling capabilities to check and control bad loans and a better understanding of their customer segments. This makes them the perfect conduit for delivering credit to MSMEs. Not only NBFCs had shown success in their traditional bastions, but they also managed to build substantial assets under management (AUM) in the personal loan and housing finance sector. “Going forward, the latent credit demand of an emerging India will allow NBFCs to fill the gap, especially where traditional banks have been wary to serve. Additionally, improving macroeconomic conditions, higher credit

© Springer Nature Singapore Pte Ltd. 2019 R. Kannan et al., Non-Banking Financial Companies Role in India’s Development, India Studies in Business and Economics, https://doi.org/10.1007/978-981-13-3375-0_4

61

62

4 Acceptability of NBFCs to the Public

penetration, increased consumption and disruptive digital trends will allow NBFC’s credit to grow at a healthy rate of 7–10% (real growth rate) over the next 5 years. Clearly, the NBFCs are here to stay” (PwC 2016).

4.1 Retail Business Growth Most NBFCs are retail focused. They have invested a lot in technology which has brought down their operating costs. The NBFCs retail business has grown at a compound growth rate of above 20% per annum from 2011 to 2014. At this rate, the market share of NBFCs is likely to grow at a higher rate than that of scheduled commercial banks. During 2007–10 the traditional vehicle financing business exhibited some volatility but the new segments such as gold and loan against property have shown higher growth rates. The major factor contributing to this phenomenal growth is the focused efforts of NBFCs in spreading their wings in second- and third-tier cities. Hence, the NBFCs understand the chemistry of regional dynamics which help them to build strong customer relationship. The NBFCs also continuously engaged in product innovation, and this has enabled them to improve their competitive positioning. In the last 2 years, NBFCs had to face a number of challenges, but this has only helped them emerged stronger and more matured. In this chapter, we look at various parameters that have contributed to NBFCs achieving higher growth.

4.2 Product Differentiation In the last few years, the NBFCs have developed products which had more public appeal and they are totally different from what the commercial banks could offer. Most of the commercial banks offer products which do not match the customer requirement exactly. In a country like India, the demand for products and financial services varies widely across the country, and the banks have not taken any serious and committed efforts to alter the products to suit the customer’s requirements, whereas the NBFCs are in a position to alter the features of the products so that they can meet the requirements of the consumers. The enhanced flexibility in the products offered is the major contributing factor. Table 4.1 gives the share of NBFCs in the retails finance during 2012 and 2017. The share of NBFCs has significantly increased from 26 to 30%. The major factors which are responsible for this growth rate are vehicle finance, loan against property and gold loans. In addition to the products, other subsidiary conditions, namely repayment period, documents required, are all very simple in the case of NBFCs. In the last 2 or 3 years, there are some changes in the products sold by commercial banks and it is not an

4.2 Product Differentiation Table 4.1 Percentage share in retail finance

63

As at end March

Percentage share of banks

Percentage share of NBFCs

2012

74

26

2013

73

27

2014

73

27

2015

72

28

2016

72

28

2017

70

30

Source CRISIL Research’s Report on the NBFC sector April 2014 and other reports Table 4.2 Market shares of NBFCs (in %)

Year

Gold

Housing Infrastructure

Auto

Microfinance

2012–13 27

37

33

48

28

2013–14 22

37

33

50

30

2014–15 23

38

35

49

39

2015–16 25

38

38

50

50

2016–17 25.9

40

39

50

53

Source CRISIL research

exaggeration that they have taken lessons from NBFCs, i.e. in vehicle finance, gold loan and loan against property. The semi-urban and rural segments account for more than 50% of NBFCs retails business. “A significant part of the growth seen in NBFCs is therefore also a form of substitution of the credit typically extended by the unorganized sector, thereby contributing to the financial inclusion agenda”. A study by CRISIL has revealed that some of the large NBFCs have been able to increase their operational efficiency (measured by business per branch) by 35–40% during 2014–17, further contributing to their business growth. Table 4.2 explains the niche position of NBFCs with respect to gold, housing, infrastructure, auto and microfinance loans. Since 2012–13, the percentage share of microfinance and auto had increased, while the share of gold was almost stagnant and the share of infrastructure and housing declined.

4.3 Procedural Convenience The legal procedure followed by the commercial banks in granting loans especially loans for vehicle finance, loans against property and gold loans is time-consuming and cumbersome. As per the norms prescribed by the respective central office, they have to follow formalities, whereas the NBFCs could provide loans with minimum

64

4 Acceptability of NBFCs to the Public

procedural requirements and this is free from cumbersome procedures. In addition, the loans are made available at short notice after submitting the loan application, whereas the banks take quite some time in approving the loans. For procedural convenience, lease finance is a clear example. Banks take quite a long period in approving lease finance, whereas this is the quickest finance available for meeting the cost of capital of business enterprises, and hence, asset finance companies and lease finance companies are in a comfortable position to provide loans. One crucial question which needs to be addressed here is by sanctioning loan in the shortest period of time, where the NBFCs have sacrificed prudential limits and procedures and hence enter into risky areas. The experience shows the contrary picture as the percentage of standard assets to the total credit remains at a very high level, and gross NPA ratio is at a very low level compared to the scheduled commercial banks. This clearly focuses that NBFCs have not diluted the core aspects of credit appraisal.

4.4 Effect on Borrowing Capacity In business, if a firm increases the debt without increasing the share capital, this will lead to an increase in debt–equity ratio and a reduction in the borrowing capacity of the company in the future. Leasing finance is an important segment of finance which the NBFCs follow. Leasing is not a borrowing, and hence, the borrowing limits of the company are not affected when the company avails leasing finance from NBFCs. The benefit of leasing finance is that the leasing does not appear as debt in the company’s balance sheet. Moreover, when the companies have exhausted their borrowing limits, leasing finance is an important vehicle through which additional production could take place.

4.5 Diluting Obsolescence Risk In the modern world, technological development takes place at a rapid pace. Companies have to invest huge money when the technology is changed. This is very important in order to keep the competition at a high level and cost at a low level. The problem of obsolescence is very important during the downward phase of the business cycle. Lease finance is an appropriate tool which will address the risk of obsolescence and hence companies could take a breathing time in going for high technology. During the period of the downward phase of the business cycle, lease financing will help them to move towards high technology.

4.6 Time Tested and Borrower Friendly Appraisal Methods

65

4.6 Time Tested and Borrower Friendly Appraisal Methods Many NBFCs-D are following established credit evaluation techniques. Their relationship-based approach, extensive branch network and strong valuation skills are the major contributing factors in enhancing the market share. In addition to these factors, NBFCs have also followed efficient and acceptable credit procedure, credit delivery process and relationship-based loan administration and recovery methods which help them to enhance customer loyalty. The majority of NBFCs are doing business in non-banking areas, and a significant portion of their clients belongs to middle- and low-income group. In the case of commercial banks, creditworthiness is assessed by tax returns and other related documents. Many borrowers of NBFCs do not have such records to prove their creditworthiness. However, the close contact with the neighbours and others staying in the same community are sources of information used by NBFCs in assessing the loan applications. NBFCs follow such procedures to evaluate the credit profile of their customers by generally relying on the reference from the local trading community and the value of the commercial vehicle provided as underlying collateral rather than on a stringent analysis of the credit profile. Fair degrees of stability for the NBFCs are obtained from improved investor’s confidence and wide network. The NBFCs sector withstood the economic downturn of 2007–09. No substantial/significant defaults were reported during this period.

4.7 Summing Up The above analysis clearly reveals that the acceptability of NBFCs in meeting the credit requirements of the population has increased in the recent period. This is clear if we analyse the market share of NBFCs in retail finance and products offered. It is very important to note that NBFCs could offer products which are in demand by their customers. But at the same time, it is also clearly borne out that safety aspects of lending were not sacrificed by them, as all prudential ratios are within the acceptable safe limits for BFCs. It is also true that banks have learnt some of the credit business, e.g. gold loans, truck loans, etc., from the NBFCs only. The PwC report (2016) also revealed that strong urban demand and an increase in credit penetration continue to drive the growth in the consumer finance segment of NBFCs. Driven by higher disposable incomes through increased effectiveness of government schemes and the Seventh Pay Commission, one can confidently expect faster growth in the consumer finance segment. On the Small and Medium Enterprises

66

4 Acceptability of NBFCs to the Public

Chart 4.1 NBFCs retail AUM (in trillion Indian rupees)

(SME) front, the business and the professional loans seem to grow faster. Overall, NBFCs seem to register a robust growth of 19–22% CAGR in retail credit to reach an AUM of approximately 6.044 trillion INR by March 2017 as shown in Chart 4.1.

Chapter 5

Demand for NBFCs’ Credit

5.1 Contribution of NBFCs in Meeting Credit Requirements The NBFCs in India comprise a host of institutions. They mostly engage in investment, insurance, chit fund, nidhis, merchant banking and alternative investments as their principal business. The share of non-asset finance companies accounts for an insignificant portion of the total NBFCs. Hence, although NBFCs are witnessed to enter to various segments of financing India’s credit requirements, the contribution of other NBFCs, other than asset finance companies, is insignificant. Moreover, NBFCs are not principal financial institutions in promoting savings in India. The share of NBFCs in total household financial savings has been fairly volatile and accounted for 1.9% in 2016–17. But the contribution of NBFCs in meeting the credit requirements is quite pronounced. Vehicle financing, loan against property and gold loans account for a substantial portion, and in the retail sector, the share of NBFCs has increased from 26% in March 2007 to 47% in end March 2013 in total loan extended. Table 5.1 gives the share of public deposits, bank borrowings and loans and advances as a per cent of total liabilities/total assets. This gives a clear idea that NBFCs do not stand as a primary institution to mobilize deposits, but their contribution in meeting the credit requirements are very much pronounced. Total loans and advances as a per cent of total assets increased from 65.67% in 2005–06 to 75.5% in 2009–10. After then, it increased to 88.9% in 2016–17, which is mainly due to strong credit growth seen in the last 3 years. The growth has been driven by segments like auto finance, gold loans and construction equipment loans, which have performed better than the larger sectors such as housing and infrastructure finance (CRISIL 2014). The (asset) growth of the NBFCs sector in India is much more pronounced compared to the growth of the banking sector during the last 5 years as evidenced in Table 5.2. © Springer Nature Singapore Pte Ltd. 2019 R. Kannan et al., Non-Banking Financial Companies Role in India’s Development, India Studies in Business and Economics, https://doi.org/10.1007/978-981-13-3375-0_5

67

68 Table 5.1 Share of public deposits, bank borrowings and loans and advances of NBFCs-D (in %)

5 Demand for NBFCs’ Credit

Year

Public deposits as % of total liabilities

Bank borrowings as % of total liabilities

Loans and advances as % total assets

2005–06

6.47

65.94

65.67

2006–07

4.28

66.84

52.57

2007–08

2.74

67.83

47.08

2008–09

2.56

72.47

53.06

2009–10

3.0

68

75.5

2010–11

3.9

66.48

74

2011–12

4.66

33

58

2012–13

5.69

27.48

73.4

2013–14

13.8

27.59

84

2014–15

14.6

29.9

86

2015–16

11.3

27.5

88.3

2016–17

11.1

22.3

88.9

Reports on trend and progress of banking in India (various years)

The share of NBFCs in systemic credit has grown in the past few years to 16%. While 63% of this demand is met by banks, the remaining is met by the capital market and external commercial borrowings (ECBs). The share of credit grew ~19% CAGR between fiscals 2012 and 2017. Thus, the NBFCs account for a significant share in total credit demand in India, and the growth momentum is expected to continue.

5.2 Credit Demand While analyzing the demand for credit, two approaches are possible, viz. one based on incremental capital output ratio (ICOR) and another based on multiple regression analysis. In the case of ICOR, one can work out the trend rate of ICOR and given the growth rate of GDP, one can estimate the investment amount required to reach that growth rate. From this investment required, if we deduct bank credit, one can estimate the credit demand from the non-banking sector. This will also indicate the demand for credit which is not fulfilled by the banking sector. The major issue with this approach is one will get a demand for credit which goes into proper investment. But both banks and NBFCs also give credit which would facilitate the investment and which are somewhat working capital in nature. In view of this limitation, this approach was not used here. Moreover, in the estimation of trend ICOR, there is no unique approach. Different approaches give different values, and this makes the estimation of unfulfilled demand for credit very cumbersome. In view of these limitations, this approach is not used.

22.0

26.9

8,667

19.2

71,834

2010–11

22.0

10,575

15.8

83,209

2011–12

Source Report on trend and progress of banking in India, RBI; CRISIL research

Growth %

6,830

5,600

NBFCs

60,269

15.0

52,386

2009–10

Growth %

Banks

2008–09

Table 5.2 Growth of total assets of banks and NBFCs

14,111 9.8

21.5

14.5

109,759

2013–14

12,852

15.3

95,900

2012–13

4.6

14,767

9.7

120,370

2014–15

16.7

17,231

9.1

131,293

2015–16

14.2

19,672

7.8

141,586

2016–17

5.2 Credit Demand 69

70

5 Demand for NBFCs’ Credit

So far as the second approach is concerned, we use the following regression model, viz. (5.1) Demand for real credit = f{real GDP, inflation, lagged value of the demand for real credit} where the real credit is total credit (TOTCR) deflated by the wholesale price index (WPI), which represents inflation.1 Using log-log specification, the above equation can be written as: (5.2) ln (TOTCR/WPI)t = α + β1 lnGDPRt + β2 lnWPIt + β3 ln (TOTCR/WPI)t−1 The above equation is estimated using the data during the years from 1995–96 to 2015–16. The estimated results are shown below as: (5.3) Ln (TOTCR/WPI)t = −1.7173 + 1.1021LnGDPRt – 0.4385LnWPIt + 0.4751Ln (TOTCR/WPI) (5.64) (3.16) (2.64) R Bar Sq. = 0.91 D.W. Stat = 1.92 (Figures in brackets are t values) Results imply that the real GDP has a positive and significant impact on demand for real credit, while inflation has a negative and significant impact on demand for real credit. The lagged term has a positive and significant impact on demand for real credit.

5.3 Alternative Credit As per the Tracxn report on alternative lending in India, “the number of start-ups in the online consumer lending space has grown significantly from 2 in 2013 to 30 in 2015. These firms either operate as NBFCs, intermediaries for banks/NBFCs or serve as a P2P lending marketplace to connect individual borrowers and lenders directly”. These start-ups have used a variety of non-traditional data to evaluate credit risk and to the identity of an individual and their intent and ability to repay the loan. Due to this approach of scientifically matching, the appropriate borrower profile with the best-suited lender, there have been higher chances of loan approvals with lower interest rates. P2P firms levy a registration fee and earn huge commission amounts from lenders and borrowers. Additionally, they offer customers scope for negotiation of interest rates, enabling borrowers to obtain capital at a lower cost and investors to earn lucrative returns. These firms assist individuals (salaried or self-employed) and small businesses in obtaining personal, auto, working capital and other loans. Due to their simplicity, speed and convenience, these alternative lending companies attracted a large number of customers over the years. Further, they extend timely credit to otherwise ineligible 1 We

deliberately avoided the use of capital goods price deflator. We have estimated ‘total credit demand’ by NBFCs by the credits extended by banks from total credit demand. That is, the balance is the portion of the credit demand, contributed by NBFCs.

5.3 Alternative Credit

71

Chart 5.1 Growth of online consumer lending in India. Source Tracxn Alternative Lending Landscape, India—July 2015

Chart 5.2 Growth of online consumer lending in India. Source PwC (2016)

borrowers under the traditional lending system and provide numerous features/tools for enriched and seamless customer experience. Their special features including online tools/calculators, knowledge centres, live chats, ability to track application status, etc. have increased greater awareness and customer satisfaction. Chart 5.1 shows the growth of online consumer lending in India, while Chart 5.2 shows the year-wise number of online customer lending start-ups in India since 2008.

72

5 Demand for NBFCs’ Credit

5.4 Summing Up The share of public deposits with NBFCs has come down significantly, and the public do not consider the NBFCs deposits as lucrative compared with other alternatives available. In addition, various regulatory measures introduced by the RBI have discouraged the NBFCs to mobilize deposits from the public. Although the share of public deposits with NBFCs declined during 2005–11, in the last 2 years this has increased slightly, which is a company-centric phenomenon and not economy-wide feature. On the other hand, the role played by NBFCs in meeting the credit demand is truly commendable, and the econometric exercise clearly proves this feature. The NBFCs contribute about 15–23%, of unfulfilled credit demand which is significant for the growth of the economy and in particular it helps the vulnerable section of the population to get some employment opportunities and also in meeting their consumption requirements. Hence, the NBFCs no doubt play a crucial role in augmenting the credit in the economy, and in this process, they also contribute to enhance the income of this segment of the population. On the basis of this equation, it is estimated that NBFCs’ credit is expected to have a share of 5–7% of the total credit and in the unfulfilled portion of the total credit demand, unmet portion of the credit is total demand for credit estimated less credit from banks, and NBFCs meet 15–23% of the credit. In a period of high demand for credit, this share even touches 28%.

Chapter 6

Risk Management in NBFCs

6.1 Risk Management Risk management has become the ‘mantra’ for all segments of financial sector. The RBI has already positioned the risk management process for banks and the same has been introduced for NBFCs-D. But it has to take a strong root in NBFCs. Understanding the concepts of risk management gives an additional value for the financial institutions in their endeavour to maximum risk-return profile. This will also help them to understand the clear picture of the risk-return trade-off in which the financial institution is engaged (Fabozzi and Konishi 1991). There are several dimensions where the regulator needs to focus while supervising the activities by the NBFCs. a. Systemic Risks It is often argued that NBFCs tend to generate severe systemic risk in the economy as NBFCs try not to adequately internalize such risks. Systemic risks are often referred to a component of total risks that relates to the movement of the whole economy and cannot be diversified away. In essence, a large systemic risk borne by the NBFCs would lead to a compounding of losses during the crises. b. Regulatory Arbitrage One of the primary objectives of the prudential regulation is to provide a level playing field to all the financial intermediaries in economy. In other words, regulator should abet the risk of regulatory arbitrage arising from different regulatory constraints imposed on the same products offered by different institutions. This has been a highly contentious issue during the Asian crises in the late 90s, where the totally unregulated NBFCs in many such countries like Thailand, Malaysia and Korea have got themselves involved in financial business without following the prudential norms imposed on banks. Therefore to prevent regulatory arbitrage across various financial institutions a coherent regulatory framework, which regulators similar risks in similar ways regardless of its origin, is essential for an economy. © Springer Nature Singapore Pte Ltd. 2019 R. Kannan et al., Non-Banking Financial Companies Role in India’s Development, India Studies in Business and Economics, https://doi.org/10.1007/978-981-13-3375-0_6

73

74

6 Risk Management in NBFCs

c. Market Misconduct One of the primary concerns of the regulator is to protect the depositors against a default wherein NBFCs fail to repay. In a perfect market, it is expected that the investors make an informed decision about their investment based on all available information. However, in reality there is an asymmetry of information between the depositors and NBFCs. The customer may not have the full information to determine the value of the promise made by NBFCs. The main role of the regulator is to ensure there are certain rules of conduct in place which protect the consumer from false promises, conflict of interest and agency issues. Specifically, regulatory framework should contain norms including the entry, financial and non-financial disclosure, conduct of business, etc.

6.2 Risk Profile of NBFCs The risk profile of NBFCs is somewhat different from banks, as credit risk and asset–liability mismatch risk becomes more pronounced for NBFCs than that for banks.1 Although the non-performing asset (NPA) ratio of NBFCs is lower than that of banks, the credit risk is a candidate which needs to be paid due attention. The next important risk for NBFCs is the liquidity risk. As explained earlier, the NBFCs are no longer the financial institutions, which people look for savings. On the other hand, the contribution of NBFCs in lending is quite substantial. The main sources of lending are borrowings. Hence, unlike banks, which have a strong source of deposits, the NBFCs significantly depend on borrowings to support their lending activities. Hence, the liquidity risk is very important and more pronounced than for banks. For any financial institution, which borrows and lend, the importance of asset –liability management cannot be ignored because the Asset-Liability Management (ALM) is a process by which an institution manages its balance sheet to address the changing environment of interest rates and liquidity developments. By this process, the financial institutions protect themselves against the risks they face. The ALM is an also first step in the long-term strategic planning process. The RBI has introduced the ALM system for NBFCs from March 2002. The NBFCs usually involve in risk transformation. This would compel them to maintain a good balance among spreads, profitability and long-term viability. In order to sustain the benefits, one should not look only at the short-term effect, but long-term 1 According to the latest Financial Stability Report by RBI (in September 2017), “Stress test on credit

risk for NBFCs carried out for the period ended September 2017 under three scenarios: increase in GNPAs by (i) 0.5 SD, (ii) 1 SD and (iii) 3 SD revealed that in first scenario, the sector’s CRAR declines marginally to 22.4% from 22.5%. In the second scenario, the CRAR goes down to 22.3% and in the third scenario, it declines to 21.9%”. The stress test results for individual NBFCs also indicated that under scenarios (i) and (ii), around 7% of the companies are not able to comply with the minimum regulatory capital requirements of 15%. Around 10% of the companies are not able to comply with the minimum regulatory CRAR norm under the third scenario.

6.2 Risk Profile of NBFCs

75

also. Hence, the NBFCs need to take their business decisions based on a dynamic and integrated risk management system and process driven by corporate strategy. Credit risk, interest rate risk, equity risk, liquidity risk and operational risks are some of the major risks exposed by NBFCs. Of these, the interest rate and the liquidity risks are more important as they are part of their ALM function. The initial focus of the ALM function would be to enforce the risk management discipline, i.e. managing business after assessing the risks involved (RBI 2001). “The ALM process rests on three pillars: (a) ALM information systems • Management information system • Information availability, accuracy, adequacy and expediency (b) ALM organization • Structure and responsibilities • Level of top management involvement (c) ALM process • • • • •

Risk parameters Risk identification Risk measurement Risk management Risk policies and tolerance levels” (Asha 2014).

Measuring and managing liquidity are very important for NBFCs, as their dependence for deposits have declined due to strong regulations. By assuring NBFCs ability to meet its liabilities, appropriate liquidity management can reduce the probability of an adverse situation developing. The importance of liquidity transcends individual NBFCs, because the liquidity shortfall in one NBFC can have repercussions on the entire system. This is all the more pronounced since the interaction between banks and NBFCs have become more pronounced in the recent years. The liquidity crisis faced by NBFCs during 2008–09 is a clear example to underscore the importance of liquidity management. The important lessons learnt clearly underscore that the NBFCs should measure not only the liquidity positions on an ongoing basis but also examine how liquidity requirements are likely to evolve under crisis scenarios. Evidences indicate that while assets are commonly considered as liquid-like government securities and other money market instruments, they also become illiquid when the market and players are unidirectional. So it is necessary to track the liquidity through maturity and cash flow mismatches. For measuring and managing net funding requirements, we need to use the maturity bucket and calculation of cumulative surplus or deficit of funds at selected maturity dates. The Reserve Bank of India has prescribed the following time buckets for NBFCs: • 1 month • 1–2 months

76

6 Risk Management in NBFCs

Table 6.1 Weighted mean of deposits of NBFCs-D

Year

Weighted mean number of deposit

Weighted mean amount of deposits (| Crore)

2007–08

47

82.75

2008–09

49

83.2

2009–10

54

85.0

2010–11

54

91.3

2011–12

59

93.7

2012–13

60

96.29

Source Report on trend and progress of banking in India, RBI various issues

• • • • • •

2–3 months 3–6 months 6–12 months 1–3 years 3–5 years and Above 5 years.

The NBFCs accepting public deposits are required to invest up to 15% of their public deposits in approved securities and for RNBCs, this is up to 80%. The RBI has also prescribed the rules for maintaining the trading book. Gap analysis that measures mismatches between rate sensitive liabilities and rate sensitive assets needs to work out the gap or by calculating gaps over different time buckets at a given date. Let us analyse the weighted distribution of public deposits held by NBFCs-D. Table 6.1 gives the weighted mean of the number of deposits and amount of deposits over a range of less than |0.5 crore to |50 crore and above. One can observe a high degree of concentration of deposits from Table 6.1. A few numbers of deposits account for a large share in total deposits. This clearly indicates the concentration risk present in the deposit mobilization. The weighted mean interest rate of deposits increased from 6.5% in 2007–08 to 11.3% in 2012–13. The weighted maturity of deposits did not show any significant change as this was 2.479 years in 2007–08 and 2.55 for the year 2012–13. On a sample basis, we analysed the gap between the assets and liabilities for two sample group, one for big NBFCs which has assets under management of over |1000 crore and another with AUM below |500 crore. When we conducted interest rate scenarios, this clearly shows that big NBFCs are well equipped to handle the interest rate risk, but the small NBFCs, with AUM less than |500 crore are not well placed (see Table 6.2). Thus, the ALM risk is more pronounced for small NBFCs, and they have to pay enough attention to reduce interest rate risk. We have to take this result with caution, as the sample is very limited. But the result is worth noting.

6.3 Economic Capital Table 6.2 Percentage distributions of assets and liabilities over various time buckets

77

Time bucket

Big NBFCs Assets

Small NBFCs Liabilities Assets

Liabilities

Up to 1 month

5

3

9

17

1–2 months

6

7

12

14

2–3 months

6

5

11

14

3–6 months

24

20

17

22

6–12 months

15

13

18

16

1–3 years

12

17

11

4

3–5 years

17

19

17

6

Above 5 years

15

16

5

7

Source Reports on trend and progress of banking in India (various years)

6.3 Economic Capital Although risk weights are suggested for NBFCs, we must be clear that these risk weights are the same for all NBFCs irrespective of the risk they carry in their balance sheets. The only durable solution lies in moving towards economic capital, so that the NBFCs are well equipped to handle their risk management and hence their economic capital. The time has come for RBI to suggest the move towards economic capital calculations for NBFCs, and this could replace current percentage capital prescription.

6.4 Interconnectedness Between Banks and NBFCs As the economy grows and the share of service sector increases, financial deepening happens. This financial deepening contributes to the strengthening of financial relationship between various types of financial institutions in the country. As we are aware, India is a bank-dominated economy. Since 1990 reform measures, financial deepening is taking place. As a result, the interconnectedness between various types of financial institutions gets strengthened. Kroszner et al. (2010) said that this kind of financial deepening and the resultant creation of many financial layers make the system more vulnerable to shocks, as the contagion could easily pass on. That is the principal reason for why the regulators would try to position stringent prudential measure and also subject them to a number of transparency standards. There are two types of interconnectedness, viz. organizational and financial. In the former one, NBFCs are created as subsidiaries of banks or big NBFC could have banks as subsidiary. For example, HDFC Bank is the subsidiary of HGFC Ltd. Many public sector banks also have one or other forms of subsidiaries such as mutual funds, merchant banking, insurance and venture capital.

78

6 Risk Management in NBFCs

NBFCs borrow substantial amounts from banks, while some are secured others are unsecured. In addition, NBFCs borrow money from financial institutions other than banks. During 2005–11, the borrowing from banks for NBFCs-D has significantly increased from |44.43 billion to |698 billion. But since then this has declined. But during 2014–16 again, this has increased. This is due to various stringent measures put by the RBI. But once the NBFCs-D had positioned strong prudential measures, their borrowings also increased along with the confidence of the banks. NBFCs-D borrowing from the Financial Institutions is very small. Borrowing from banks is almost 20 times the borrowings from Financial Institutions. In the last few years, the share of secured lending has significantly increased and this would reduce the credit risk of NBFCs (see Table 2.7).

6.5 Prudential Parameters a. Capital to risk-weighted asset ratio (CRAR): Capital to risk-weighted asset ratio (CRAR) is prescribed for NBFCs-D. Although major NBFCs-SI-ND are also subject to CRAR regulation, data are not available. Throughout the period 2005–16, CRAR of NBFCs-D is much higher than that of SCBs. Up to 2011–12, CRAR of NBFCs-D was almost 2.5 times that of scheduled commercial banks (SCBs), but after this period this ratio declined to 1.5 times. This is mainly due to stringent provisions for NPAs and almost stagnant growth of paid-up capital and reserves. In spite of this, this comparison clearly says that NBFCs are much comfortable so far as capital is concerned than that of SCBs (Table 6.3). Table 6.3 CRAR of NBFCs-D and commercial banks Year

NBFCs-D

Scheduled commercial banks

2004–05

26.3

12.8

2005–06

30.1

12.3

2006–07

31.4

12.3

2007–08

29.2

12.6

2008–09

31.3

13.2

2009–10

31.8

13.6

2010–11

30.4

13.02

2011–12

29.3

12.94

2012–13

28.1

13.9

2013–14

22.0

13

2014–15

21.7

13

2015–16

20.1

13.3

2016–17

19.9

13.6

Source Report on trend and progress of banking in India, RBI; CRISIL research

6.5 Prudential Parameters

79

b. Non-performing Ratio Gross NPA of NBFCs-D was high at 5.7%, highest in the period 2005–17, and then started declining and touched lowest of 0.7% in 2011. Since then it has been continuously increasing. Gross NPA for NBFCs-SI-ND was highest at 7% in 2006, but declined thereafter. It reached lowest level of 2.2% in 2013, but since then this increased and was at 6.1% in 2017. If we compare the NPA ratio of SCBs and NBFCs, we get an interesting picture, except for the year 2006, NPA is higher for SCBs than that if NBFCs-D. On the other hand, NPA for SCBs is lower than that of NBFCs-SI-ND, except for 2012–13. Net NPA also revealed similar trend. It is interesting to note that during 2008–11, net NPA for NBFCs-D is negative due to high provisions. This comparison clearly indicates that non-performing asset ratio is very much comfortable for NBFCs than that of SCBs. This is mainly due to the business model which NBFCs follow as they maintain very close contact with the borrowers and their credit appraisal is very robust. In majority of cases, they also ensure the end use of credit for which this was given. All these factors contribute to the comfortable position of NPAs (Table 6.4). c. Stress Test on Credit Risk for NBFCs According to the latest Financial Stability Report by RBI (in September 2017), “Stress test on credit risk for NBFCs” carried out for the period ended September 2017 under three scenarios: increase in GNPAs by (i) 0.5 SD, (ii) 1 SD and (iii) 3 SD revealed that in first scenario, the sector’s CRAR declines marginally to 22.4% from 22.5%. In the second scenario, the CRAR goes down to 22.3%, and in the third scenario, it declines to 21.9%. The stress test results for individual NBFCs also

Table 6.4 Non-performing assets of banks and NBFCs Year

NBFCs-D

NBFCs-ND-SI

Banks

Gross NPA

Net NPA

Gross NPA

Net NPA

Gross NPA

2004–05

5.7

2.5

2.3

2.7

4.9

2005–06

3.6

0.5

7

2.6

3.3

2006–07

2.2

0.2

4.9

2.5

2.5

2007–08

2.1

#

3.1

1.09

2.3

2008–09

2.7

#

2.9

1.25

2.3

2009–10

1.3

#

3

0.69

2.4

2010–11

0.7

#

1.7

1.2

2.5

2011–12

2.2

0.5

2.3

1

3.1

2012–13

2.4

0.8

2.2

2

3.2

2013–14

3.1

1

2.6

1.5

3.8

2014–15

3.5

1.1

2.9

1.7

4.3

2015–16

4.9

1.7

4.3

2.7

7.5

2016–17

5.9

2.1

6.1

4.4

9.3

Source Report on Trend and Progress of Banking in India, RBI; CRISIL research

80

6 Risk Management in NBFCs

indicated that under first two scenarios, about 7% of the them do not comply with the minimum regulatory capital requirements of 15% and under third scenario, about 10% of them do not comply with the minimum regulatory CRAR norm.

6.6 Summing Up It is amply proved that the NBFCs play an important role in credit disbursement in India. In the last few years, they rely on borrowings to finance the credit. These borrowings could be from banks or from market. But borrowings lead to credit risk and liquidity risk. Based on the developments during 2008–09, the liquidity risk management is equally important for NBFCs as for the banks. In addition, the NBFCs must also address the ALM risk; otherwise, this could lead to credit risk and in turn contagion risk. Based on a very limited sample, the exercise done clearly reveals that interest rate risk is more pronounced for small NBFCs than for big NBFCs, whose capital is more than |. 500 billion. As the RBI has already positioned various risk management procedures for NBFCs, a move towards the calculation of economic capital may be considered.

Chapter 7

Financial Inclusion and NBFCs

7.1 Importance of Financial Inclusion While it is globally accepted that the development of financial services is essential for growth of any economy, it is only recently that many nations including India have realized that benefits of growth might not trickle down to the lower strata of the society unless it is inclusive. This inclusive financial growth refers to a system that ensures easy availability of safe, cheap and formal financial services to the poor and disadvantaged sections of the society (Carbo et al. 2005; Conroy 2005; Leyshon and Thrift 1995; Mohan 2006; Rangarajan Committee 2008). A recent study by Demirguc-Kunt and Klapper (2012) suggests that inequality in the use of formal accounts (using World Bank Global Findex Survey) and general income inequality (measured by the Gini coefficient) are highly interdependent, wherein the higher values suggest higher income inequality (Chart 7.1). The correlation between these two measures of financial and economic inequality is 0.42 indicating a strong direct (positive) relationship, which holds even after controlling for national income. Further, the study also highlights that while the financial development constitutes two distinct aspects like financial inclusion and financial depth; however, they are seldom correlated implying that financial depth does not necessarily ensure access to finance for all the strata of a society. Country examples, including India, corroborate the fact that financial inclusion is not perfectly correlated with a common instrument of financial depth (Chart 7.2). India, for example, despite its strong growth experience with 51.8% domestic credit to private sector to GDP ratio scores very poorly with respect to universal financial inclusion. In stark contrast, banks catered to only 35% of adults in India, while only 8% borrowed from formal sources. While the account penetration in India is just below the rest of the developing world, it is significantly lower than that of the other BRICS economies—Brazil, Russia, China and South Africa. Only 7% of

© Springer Nature Singapore Pte Ltd. 2019 R. Kannan et al., Non-Banking Financial Companies Role in India’s Development, India Studies in Business and Economics, https://doi.org/10.1007/978-981-13-3375-0_7

81

82

7 Financial Inclusion and NBFCs

Chart 7.1 Correlation between inequality in the use of formal accounts and inequality in income

Chart 7.2 Account penetration in India by individual characteristics

the villages in India have bank branches. Therefore, the issue of financial inclusion as development policy has gained priority and subsequently more and more studies have emerged on this topic both in developed and in developing countries. Advantages of financial inclusions have therefore been distinctly documented in the literature which includes efficient allocation of resources. And since the access to formal credit becomes easier and cheaper, the dependence on risky informal sources

7.1 Importance of Financial Inclusion

83

of credit, like moneylenders, can be reduced potentially.1 However, it is also observed that financial inclusion is a multidimensional phenomenon and its efficacy significantly varies across different dimensions, geographical regions and time (Beck et al. 2007a, b; Honohan 2008; Pal and Vaidya 2011).2 Therefore, it is imperative to evaluate the impact of financial inclusion keeping in mind all these important factors. Recognizing the need for better financial inclusion in India, this chapter aims to examine the present scenario of financial inclusion in India and the role of non-banking financial companies (NBFCs) in filling the gaps in the unmet financial requirements for India, particularly in the context of the Micro, Small and Medium Enterprises (MSME) sector in India.

7.2 An Overview of Financial Inclusion in India While India is the fourth largest economy globally in terms of purchasing power parity (PPP) basis and ranked ninth on a market exchange rate (MER) basis, it has the highest number of households (145 million) with no access to formal banking, with 650 million adults without formal source of borrowing. Out of 406 million mobile users in India, only 187 million have access to sources of formal banking. Further, there is a vast difference between urban and rural India. While in urban area of India, 60% of population are covered by formal banking system, the rural area presents a dismal scenario of 39% of bank coverage.3 Moreover, this 60% in urban area could be potentially misleading number, as an individual might hold multiple accounts. Further, the scenario in the low-income bracket is even worse. According to various reports, while only 34% of people with annual income less than |50,000 had a bank account, in rural India it is only 26.8%. In addition, The Economic Survey 2018, noted that “country’s life insurance penetration was 2.72% and general insurance penetration was 0.77%; this compares to a global insurance penetration of 3.47% for life and 2.81%, respectively”.

1 Additionally,

access to basic financial services can significantly improve day-to-day management of finances. 2 The position of a country may be quite good in one dimension of the financial inclusion but not in another dimension. Therefore, one may get only partial information on financial inclusion from individual dimension. 3 Only 33,800 (5.2%) villages out of 650,000 villages have bank branches even though 39.7% of the overall branch network of Indian banks, or 31,727, are in rural India. The population covered by each branch has come down from 63,000 during 1969 to 16,000 in 2007 and the total number of checkin accounts held at commercial banks, regional rural banks, primary agricultural credit societies, urban co-operative banks and post offices during this period has risen from 454.6 million to 610.3 million. (Source: https://economictimes.indiatimes.com/industry/banking/finance/banking/villageover-5000-residents-to-have-bank-branches-by-march-2017/articleshow/50399115.cms).

84

7 Financial Inclusion and NBFCs

Table 7.1 World bank’s Findex-select indicators on financial inclusion (2017) (Proportion of population of age 15+) Indicators

USA

UK

Germany Russia

Brazil

China

Loan from a financial institution in the past year

28.9

17.6

19.6

Loan in the past year

77.4

74.6

64.1

Personally paid for health insurance

na

na

na

Cheques used to make payments

65.5

50.1

Electronic payments used to make payments

89

Mobile phone used to pay bills

India

13.9

8.6

8.6

6.6

41.3

40.0

44.7

42.4

6.7

7.6

47.2

6.8

7.2

5.2

6.7

1.8

6.7

94.2

96.5

61.6

45.9

60.9

20

28

18.2

5.7

10.1

4.0

16.9

1.3

Saved at a financial institution in the past year

62.2

63.7

55.4

13.5

14.5

34.8

19.6

Saved any money in the past year

79.3

74

75.7

36.2

32.5

51.1

33.6

Source Global Findex database, 2011 and 2017

According to the World Bank’s Findex in 2017, India fared well when compared with China, Brazil and Russia in indicators like cheques drawn for payments, loans from financial institutions and other electronic modes of payment. However, it stands relatively poor when compared with developed nations like UK, USA and Germany with respect to those indicators indicating that India has to go a long way to achieve the financial inclusion standards set by the developed nations (Table 7.1).

7.3 Evolution and Progress of Financial Inclusion in India Recognizing the inadequate availability and access to formal financial services, the Government of India has taken several steps in a phased manner to cover all of its population under financial services. This evolution of financial inclusion in the country has taken place in three phases: a. First Phase (1969–1991) The first step towards bringing the financial inclusion in the country took place in the early seventies, when 14 banks were nationalized in order to expand the service and network of banks. The branches of the banks were developed for efficient mobilization of funds and channelizing the resources to the lesser privileged sections of the society. The tool of nationalization was used as an important agent of change in

7.3 Evolution and Progress of Financial Inclusion in India

85

banking network by the government. In order to distribute the benefits of economic growth to all segments of its population, strategies were drawn to make availability of credit and financial services to the public at large. This measure was envisaged as a step towards holistic development of the country. In recognition of this role and in order to cater to the financial needs of various sections of the society, policies were revised and altered from time to time. During this phase, several initiatives were taken with the objective of achieving sustainable and equitable growth. Specifically, this includes nationalization of private sector banks, creating the Lead Bank Scheme, developing branch licensing norms with focus on rural/semi-urban branches, introduction of priority sector lending norms, establishing interest rate ceilings for credit to the weaker sections and setting up of specialized financial institutions to cater the requirement of the agriculture and the rural sectors constituting the vast majority of the underprivileged population. b. Second Phase (1991–2005) In the second phase, the Reserve Bank of India (RBI) took a major initiative to ensure greater financial inclusion by introducing the concept of ‘no frill account’, with minimum or zero balance. RBI encouraged the banks to provide wider publicity to this ‘no frill’ account. RBI envisaged that this low-cost transparent account would serve various sections of the society and boost the process of financial inclusion. Further, RBI tried to expand the “Financial inclusion” based on the recommendation of Khan Committee in 2005 and the circular issued in 2006, which permitted intermediaries to offer banking and financial services. This has been envisaged as a major aid not only for banking but for other businesses, the NGOs and the government agencies as well. Realizing the need for financial inclusion, the RBI also introduced several other measures in the second phase, e.g. General Credit Cards (GCC) were offered to the poor, efforts were taken to improve customer services, KYC norms were made easier, the use of IT and intermediaries was encouraged, and SLBCs and UTLBCs were instructed to promote financial inclusion on a pilot basis. c. Third Phase (2005 onwards) In 2008, Government of India set up a committee under the chairmanship of Dr. C. Rangarajan in order to design a structure and develop strategies to promote financial inclusion. This committee made recommendations for improved accessibility to financial products like credit, bank accounts, payment services, financial advisory services and insurance to accelerate the process of financial inclusion. The main goal of financial inclusion is to widen the coverage of banking and payment services and improve the last mile connectivity especially in rural areas and thus foster sustainable development and provide employment opportunities to the rural population. In order to further strengthen the inclusion process, the committee emphasized on setting up of a National Rural Financial Inclusion Plan (NRFIP) with the objective of bringing half of the financially deprived population within the fold of financial services by 2012 and the remaining by 2015. According to the report on Currency and Finance, RBI, September 2008, this endeavour was further estimated to entail extending the semi-urban and rural branches of commercial banks and RRBs to

86

7 Financial Inclusion and NBFCs

include a minimum of 250 new cultivator and non-cultivator households in every branch each year. Further, the Rangarajan committee also moots the idea of setting up a National Mission on Financial Inclusion (NaMFI) with government taking the lead and encompassing representatives of all stakeholders. The main objective of the NaMFI is to propose the policy initiatives and supporting all stakeholders in public and private sectors and NGOs to take up promotional activities The RBI report on Currency and Finance 2008 further said “the major recommendations relating to commercial banks included target for providing access to credit to at least 250 excluded rural households per annum in each rural/semi-urban branches; targeted branch expansion in identified districts in the next 3 years; provision of customized savings, credit and insurance products; incentivizing human resources for providing inclusive financial services and simplification of procedures for agricultural loans”. The report also highlights that “The major recommendations relating to RRBs are extending their services to unbanked areas and increasing their credit-deposit ratios; no further merger of RRBs; widening of network and expanding coverage in a time bound manner; separate credit plans for excluded regions to be drawn up by RRBs and strengthening of their boards”. In addition, the report also describes the major recommendations made by the committee on co-operative banks as “early implementation of Vaidya Nathan Committee Revival Package; use of PACS and other primary co-operatives as BCs and co-operatives to adopt group approach for financing excluded groups”. Finally, the Rangarajan Committee also recommended boosting the SHGs in remote regions; providing legal status to the SHGs; measures for urban microfinance and separate category of MFIs. Apart from this, the banks are mandatorily required to open 25% of all new branches in unbanked rural areas. A glimpse of the financial inclusion in India from March 2010 to March 2017 according to various parameters is presented in Table 7.2. Although some decent progress can be observed in almost all parameter, complete financial inclusion remains a substantially unfinished agenda. In the next section, we examine the credit gap for one of the most important sectors of the Indian economy, viz Micro, Small and Medium Enterprises (MSME). The Reserve Bank of India has also positioned various measures to create a conducive and enabling environment for access to financial services by extending last mile facilities in all the unbanked villages in a phase-wise manner. During Phase I (2010–13), 74,414 unbanked villages with more than 2000 population were chosen and different banks were these regions SLBCs for coverage. Despite the presence of banking infrastructure and new accounts opened, there was no substantial banking activity in terms of transactions. In order to ensure meaningful access to banking services to the excluded section of the population, banks were advised to draw up fresh plans for 3 years (2013–16). In addition, the RBI had constituted a high-level committee on ‘Medium term path on financial inclusion’. This committee submitted its report in December 2015 and recommended a number of steps, which includes inter alia, welfare schemes for female children, a low-cost solution-based mobile technology, phasing out of the interest subvention scheme, create an open specialized interest-free window with

7.3 Evolution and Progress of Financial Inclusion in India

87

Table 7.2 Progress of financial inclusion plan Particulars

EndMarch 2010

EndMarch 2011

EndMarch 2012

EndMarch 2013

EndMarch 2014

EndMarch 2015

EndMarch 2016

EndMarch 2017

Banking outlets in villages—branches

33,378

34,811

37,471

40,837

46,126

49,571

51,830

50,860

Banking outlets in villages—Branchless mode

34,316

81,397

1,44,282 2,27,617 3,37,678 5,04,142 5,34,477 547,233

Banking outlets in villages—Total

67,694

1,16,208 1,81,753 2,68,454 3,83,804 5,53,713 5,86,307 598,093

Urban locations covered through BCs

447

3,771

5,891

27,143

60,730

96,847

1,02,552 102,865

Basic savings bank deposit A/c through branches (No. in million)

60

73.13

81.2

100.8

126

210

238

254

Basic savings bank deposit A/c through branches (Rs billion)

44

57.89

109.87

164.7

273.3

365

474

691

Basic savings bank deposit A/c through BCs (No. in million)

13

31.63

57.3

81.3

116.9

188

231

280

Basic savings bank deposit A/c through BCs (Rs billion)

11

18.23

10.54

18.2

39

75

164

285

BSBDAs—Total (No. in million)

73

104.76

138.5

182.1

243

398

469

533

BSBDAs—Total (Rs billion)

55

76.12

120.41

182.9

312.3

440

638

977

OD facility availed of in BSBDAs (No. in million)

0.2

0.61

2.71

4

5.9

8

9

9

OD facility availed of in BSBDAs (Rs billion)

0.1

0.26

1.08

1.6

16

20

29

17

KCCs—Total (No. in million)

24

27.11

30.24

33.8

39.9

43

47

46

KCCs—Total (| billion)

1,240

1,600.05 2,068.39 2623

3,684.50 4,382

5,131

5,805

GCC—Total (| million)

1

1.7

2.11

3.6

7.4

11

13

GCC—Total (| billion)

35

35.07

41.84

76.3

1,096.90 1,302

1,493

2,117

ICT-A/c-BC-total transactions (No. in million)

27

84

156

251

329

477

827

1,159

ICT-A/Cs-BC-total transactions (| billion)

7

58

97

234

524

860

1,687

2,652

9

Note BSBDA, Basic savings bank deposit account; BC, Business correspondent; OD, Overdraft; ICT A/c, Information and communication technology-based accounts through BCs; GCC, General credit card; KCC, Kisan Credit Card Source RBI note on financial inclusion

88

7 Financial Inclusion and NBFCs

simple products, exploring a system of professional credit intermediaries, creating a registry for ‘Banking Correspondents’, strengthening the financial literacy centre network and Grievance Redressal Mechanism etc. While some are already implemented, others are in the pipeline. The RBI also set up ‘financial inclusion fund’ and ‘financial inclusion technology fund’ in 2007–08 for a 5-year period with a corpus of | 5 billion for each to be contributed by GOI, RBI and NABARD in the ratio of 40:40:20. The FIF aims to support developmental and promotional activities leading to greater financial inclusion. The GOI has also launched Pradhan Mantri Jan Dhan Yojana on 28 August 2014 for extending formal financial services to the excluded population. This scheme aims to (i) open a basic saving bank deposit (ii) accidental insurance cover (|0.1 million) and life insurance cover (|30,000) and (iii) an overdraft facility after satisfactory operation of the account for six months. The GOI has decided to route all direct benefit transfers through these bank accounts. Although the progress was very impressive in the initial years, in the later period, this is not encouraging as many accounts become dormant. Recently, GOI allowed the Department of Posts to start India Post Payment Bank (IPPB), a public limited company with 100% GOI equity. As per the guidelines issued by the Reserve Bank of India (RBI), payments banks can accept deposits of up to |. 1 lakh and sell insurance and mutual fund products. The objective of this government and the RBI was to widen the coverage so that with more people getting access to banks, government can directly pass on the benefits of the projects sponsored by the government directly to their bank accounts. These measures could make the unbanked population financially literate and consequently, India would emerge as “the largest bank in terms of accessibility”. In addition, this could also improve country’s financial savings. However, the plan of the government to create “the largest bank in the world in terms of accessibility” and shift to a cash less economy could significantly slow down due to the lack to technological upgradation and well equipped and trained personnel. Notably, in India, by April 2016, benefits of around 56 government schemes, estimating $900 million were being transferred to 300 million people every month. But, sadly, most of these accounts are now at a dormant state since they are used to withdraw the transferred payments only. Hence, emphasis needs to be given on increasing the awareness about the operation of these accounts as well. In order to create that awareness, government needs to monitor first the transactions in the accounts and suggest measures to increase the use of those accounts. Noticeably, the past 5 years witnessed a growth of such bank accounts from 30 million to 220 million; however, the transactions in such accounts have been seen only 2.5–3. Therefore, in order to activate these dormant accounts, agent banking rules have been liberalized. Keeping in view the process of financial inclusion, the government under PMJDY took steps to bring most of the population within the fold of banking by opening 240 million bank accounts. Only the remote areas are still beyond the reach of banking services. Further, in 2015–16, under Mudra Yojana, government made a provision of | 1.20 lakh crore which was later increased to | 1.80 lakh crore in 2016–17. Major

7.3 Evolution and Progress of Financial Inclusion in India Table 7.3 Financial inclusion index of top 10 countries

Rank/55

89

Country

Score/100

Change

1

Columbia

89

3

1

Peru

89

−1

3

India

78

7

3

Philippines

78

−3

5

Pakistan

63

−1

6

Chile

62

0

6

Tanzania

62

0

8

Kenya

61

5

8

Rwanda

61

7

10

Mexico

60

0

Source 2016 Global Microscope Report

beneficiaries under the scheme were women and especially those who belonged to the needy segments of society. Due to all these efforts, India has shown a marked improvement in the financial inclusion index. According to the 2016 Global Microscope Report, India is one among top ten countries in the Microscope 2015 rankings. India has also shown a dramatic improvement in the Global Microscope between 2014 and 2016. For more details, see Table 7.3. The entire model of financial inclusion depends on ‘business correspondents’ (BC) model whereby the RBI has permitted banks to utilize the services of intermediaries known as BC. From Table 7.2, it is very clear that the contribution of BCs laid the foundation for success of financial inclusion in the banking sector. From the operations of the NBFCs, it is clear that BCs play a pivotal role in running the NBFCs. Hence, this model was almost copied and applied for the banking sector also. However, the achievement of financial inclusion under the banking sector is significantly lower than the target. The RBI Annual Report cites a number of reasons for the same. On a careful examination, one may ask a question if the banking system has used NBFCs, the achievement could be faster and durable. The spread of business for the NBFCs, fast credit disbursal methods, low level of NPAs (compared with the banks) etc., are the achievements which were made possible due to BCs model. The banking sector also follows this model for spreading financial inclusion. But it is very surprising to note that the banking sector has ignored the role and expertise available with the NBFCs in this regard. It is hoped that in order to strengthen the financial inclusion for the entire financial sector, the banks could use NBFCs more efficiently.

90

7 Financial Inclusion and NBFCs

7.4 Micro, Small and Medium Enterprises (MSME) in India The Micro, Small and Medium Enterprises (MSME) sector has played a key role and acquired a prominent status in the Indian growth story. The role of MSME in the economic and social development of the country is well established with 63.3 million enterprises across industries, employing 111 million people. It includes 20.37% enterprises led by women and 51% rural enterprises. Taken as a whole, the MSME sector generates 45% of the Indian industrial output and 40% of exports, thus contributing significantly to India’s GDP at 11.5% a year, higher than the overall GDP growth of 8%. However, 94% of MSMEs are yet to be registered. (MSME Finance in India: A Research Study, IFC 2012). Despite its critical importance, the MSME sector continues to suffer from severe credit constraints. According to the Annual Report of MSMEs in India, 93% of the 26 million of the enterprises has no access to formal sources of finance. Further, out of the total finance demand for this sector estimated as |. 32.5 trillion (Chart 7.3), recent estimates provided by IFC show that the majority of these enterprises require debt financing, estimated at approximately |26 trillion ($520 billion). The MSME sector also needs equity finance which is estimated at |6.5 trillion ($130 billion), which makes up 20% of the overall demand. However, the finance demands of the unregistered enterprises (94% of MSMEs) which account for |. 30 trillion ($600 billion) of the finance demand remains unaccounted. For details of MSME finance demand flow, see Chart 7.3. On the whole, the total supply of finance to the MSME sector, comprising both formal and informal sources, amounts to |32.5 trillion ($650 billion). An estimated |25.5 trillion ($510 billion), or nearly 78% of the finance demand in the form of debt, is met through the informal sources which also includes self-financing. Therefore, the formal sector only contributes just over 22% of the demand amounting to |7 trillion ($140 billion). |6.97 trillion ($140 billion) of the overall formal finance supply is met by banks and non-banking institutions. Commercial banks provide finance mainly in the form of debt to the MSMEs (Chart 7.4).Out of the formal financial sources |6.4 trillion (92%), credits are from the banking and government institutions to these

Chart 7.3 Financial demand flow chart for MSME sector in India. Source IFC (2012) (MSME Finance in India A Research Study) p. 14

7.4 Micro, Small and Medium Enterprises (MSME) in India

91

Chart 7.4 Formal source of credit to MSME (Formal and NBFCs). Source RBI, SIDBI, Sa-Dhan, Annual Reports of NBFC’s, Primary Research; IFC-Intellecap Analysis

enterprises. The balance |0.57 trillion (8%) of formal credit is supplied by the nonbanking finance companies (NBFCs). However, there is still a finance gap of |20.9 trillion (Chart 7.5) which needs to be met. Even if the credit demand (62% of the overall demand) from MSMEs that are considered as proprietorships or partnerships is deducted, there is still a demand-supply gap of |3.57 trillion, which potentially financial institutions can feasibly finance in future. This represents the quantum of demand-supply gap faced by approximately 11.3 million enterprises. Of the viable and addressable demandsupply gap, the debt gap is |2.93 trillion ($58.6 billion), and the equity gap is |0.64 trillion ($12.8 billion). This is further corroborated by the report of the private sector investment for MSME Subgroup that falls under the purview of working group for the 12th FiveYear Plan (2012–2017) which estimates the credit gap to total demand to be 56% for the year 2013–2014 in the MSME sector. On the basis of certain assumptions, the

Chart 7.5 Demands and supply financial gaps of MSME sector. Source RBI, SIDBI, Sa-Dhan, Annual Report of NBFCs, Primary Research; IFC-Intellecap Analysis

92

7 Financial Inclusion and NBFCs

Table 7.4 Outstanding credit demand and supply of MSMEs—projected by planning commissions: (| crore) Year

Total demand (TD)

2010–11

2,092,500

2011–12

2,308,384

2012–13

Total supply

Credit gap (CG)

CG as % of TD

737,161

1,355,339

65

874,482

1,433,902

62

2,541,574

1,038,948

1,502,626

59

2013–14

2,803,628

1,237,539

1,566,089

56

2014–15

3,089,863

1,477,928

1,611,935

52

2015–16

3,405,845

1,769,659

1,636,186

48

2016–17

3,757,755

2,124,644

1,633,111

43

Source Report of the private sector investment for MSME Subgroup under working group for the 12th Five-Year Plan (2012–2017)

Planning Commission of India has estimated the credit gap for the MSME sector at |1.62 trillion at the end of 12th Plan, viz. March 2017 (Table 7.4). Given the fact that the MSME sector has been growing at a faster rate than the overall industrial sector, this wide finance gap is threatening to derail the sector’s growth trajectory. A recent survey shows that challenge in access to finance is a major obstacle in the growth of MSME and all other multiple growth constraints (like lack of infrastructure and inadequate market linkages) are related to the inadequacy of funds (Chart 7.6). The Report of Working Group on Rehabilitation of Sick MSMEs by RBI also corroborates this fact that inadequacy of funds is one of the key reasons for sickness in the sector. Unfortunately, despite a large debt funding gap in the informal MSME sector, banks play a limited role due to the differentiated financial needs of the sector. An analysis of the MSME credit portfolios of banks suggests that banks do not contribute the required financial needs to the overall MSME sector due to the following factors: • The financial cost involved in serving and acquiring the MSMEs on the higher side. Most of these firms have a low average demand when compared to large business houses are smaller in size and geographically widely spread across the country. However, the cost, time and effort to source a client for a microenterprise are almost same as that for a medium-size corporation. Consequently, the financial institutions have less incentives to serve a microenterprise over Small and Medium Enterprises. • Lack of appropriate knowledge coupled with higher risk perception severely affect the supply of finance. • The fact that MSME is predominantly still governed by the archaic Provincial Insolvency Act, 1920, limits the options of revival for entrepreneurs. • Lack of proper accurate financial records since most of the transactions in this sector is carried out in cash, further accentuates the creditworthiness of the sector and contributes to the exaggerated risk perception. • The inherent uniqueness of MSME sector, in terms of its informal operation, lack of accessibility, lack of reliable information for effective risk assessment, and

7.4 Micro, Small and Medium Enterprises (MSME) in India

93

Chart 7.6 Challenges faced by banking sector in financing MSME sector

operational challenges to service are the main reasons for the lower share of the bank in the debt finance of MSME. Given this wide credit gap in the MSME sector coupled with the limited ability of the banks to meet this demand, the NBFCs can provide a significant mode of entry in Indian credit market with more flexibility in product offering, geographical reach, tailor made structure and speed of execution.

7.5 Summing Up The financial inclusion is an essential component of economic growth and more specifically in a developing economy like India, where a huge financial gap is prevailing in the largest MSME sector. Therefore, non-banking financial bodies being a major part of shadow banking constitute a very important part of the financial system, by enhancing the process of financial inclusion. According to the current estimate, the banking sector’s contribution to MSME is about 80% of its 7% total formal credit flow. While NBFC contributes around 20% towards meeting the financial gap, still there exists a huge financial requirement by this sector. The NBFCs have a great opportunity to work on financial product arbitrage of MSMEs where banks are not strong thereby providing possibility of securitization. It is estimated that only 5.2% of MSMEs have access to institutional finance, which is an immediate addressable opportunity for NBFCs. The NBFCs can support the MSME

94

7 Financial Inclusion and NBFCs

sector by creating a specialized lending institution in SME space with innovative product offering, by focusing on priority sector lending with its speed and simplicity in approval process. The NBFCs can succeed in its role by an enabler for effective cost control through process innovation, strong risk management framework, well-defined product policy guidelines, robust approach in credit assessment methodology, product approval and monitoring mechanism, risk-based pricing to tap value enhancement opportunity, monitoring, exception handling, collection, etc., which are already inbuilt in the system. However, due to the complex, cross-jurisdictional nature and their connections with the banking system, the risk exposure of NBFCs can assume a systemic dimension. This is further aggravated by the fact that NBFCs often face liquidity risks due to asset–liability mismatch, leading to a transformation in the maturity pattern, where the long-term assets are funded by short-term loans. In addition, these shadow banks face the risk of being highly leveraged due to the non-prudential limits on borrowings. Further, banks’ exposure to NBFCs increased from |894 billion in 2009–10 to |3135 billion in 2016–17, an increase of approximately 3.5 times, growing at a CAGR of 19.6%. The exposure of banks to the NBFC sector was | 3,910 billion as at end fiscal 2017. On the other hand, the borrowings from the markets for NBFCs increased from just |3604 billion to |10620 billion. NCDs have been the one of the largest sources of finance for the NBFC contributing to a 30% share in total funding sources. Driven by the infrastructural finance companies and gold loan NBFCs, the NSDs witnessed an extraordinary growth since March 2010. The quantum of capital raised through debenture issues doubled from |3205 billion on 31 March 2012 to |6462 billion as on 31 March 2017. Given this, the RBI needs to develop a proper policy framework to address this growing systemic risk, while recognizing the NBFCs for their contribution towards the inclusive growth. Notwithstanding, the limited systematic exposure it brings to the financial system, NBFCs play a very significant role in dealing with population segments for which the financial services are being uncovered by the formal banking system. The NBFCs are therefore better option in providing services that are not well suited to bank provision. Further, the NBFCs compete with the commercial banks in delivering financial services and thereby promote consumer-oriented measures and improve the overall efficiency of the financial system. In fact, although banks have drawn from NBFCs in their financial inclusion model, they have not really leveraged on the role and expertise available with NBFCs in this regard. The spread of business for the NBFCs, fast credit disbursal methods, low level of NPAs (compared with the banks), etc., are achievements made possible by the BC model followed by NBFCs. For banks to use NBFCs in addition to other methods would only catapult financial inclusion for the entire financial sector to another level, producing sustainable results.

Chapter 8

Banks and NBFCs in India: A Comparative Analysis

It is a well-established fact that banks occupy an important role in the economic development of India, through loans and investments for agriculture, industries and services sectors. India’s growth is predominantly bank-financed. At the same time, the role played by NBFCs also needs to be recognized. NBFCs were pioneers in auto loans, gold loans, loans to self-help groups, etc. As explained in the previous chapters, many functions of the current banking system have the route in the lending activities of NBFCs. It is also to be noted that both have never played a substitution role but complementary one. In fact, until recently banks were reluctant to lend to many unorganized sectors. It is only recently that in the name of ‘financial inclusion’, banks started lending to them. But for this group, NBFCs lent substantial money, and in the field of financial inclusion, the role played by NBFCs is significant one. This chapter is devoted to make a comparative analysis of NBFCs and Banks in India using certain selective parameters.

8.1 Asset Growths of NBFCs and Banks In order to understand the growing importance of NBFCs vis-a-vis banks in India, we compare asset size of NBFCs with asset size of banks. The NBFCs asset ratio (as a % of GDP) increased from 8.4% in 2005–06 to 10.1% in 2007–08. During this period, banks’ asset ratio increased from 75.4 to 86.8%. But in the next 3 years, the growth pattern of banks was more pronounced, but it almost stagnated for NBFCs, due to various regulatory/prudential measures implemented by RBI. After reaching a strong prudential base in 2012–13, NBFCs assets had grown to 12.9% and this is positively due to various prudential measures implemented by the RBI.

© Springer Nature Singapore Pte Ltd. 2019 R. Kannan et al., Non-Banking Financial Companies Role in India’s Development, India Studies in Business and Economics, https://doi.org/10.1007/978-981-13-3375-0_8

95

96

8 Banks and NBFCs in India: A Comparative Analysis

In the case of banks, this declined to 93.2% in fiscal 2016–17, after reaching 97.7% in 2013–14. This was mainly due to an increase in NPAs and the consequent higher provisions made to take care of them. However, in the case of NBFCs, the asset size increased to 13% in 2016–17. Thus, the growth of NBFCs is impressive. NBFCs have maintained growth momentum on a par with banks in many years and even surpassed them in some years (Chart 8.1). The proportion of NBFCs assets to bank assets has also steadily grown from 10.7% in 2008–09 to 13.9% in 2016–17, thus gaining the systemic importance (Chart 8.2). Their steady growth and increased market share are clear evidences for their success in their business models and their opportunities and potential in their target markets. 120 100

93

93

92.3

95.2

96.4

97.7

96.7

96

93.2

9.9

10.5

11.1

12.1

12.9

12.6

11.9

12.6

13

2008-09

2009-10

2010-11

2011-12

2012-13

2013-14

2014-15

2015-16

2016-17

80 60 40 20 0 Banks

NBFCs

Chart 8.1 Asset growth of NBFCs and banks in India 15 13.9

14

13.4

13

13.1

12.9

12.7

12.3

12.1

12 11.3

11

10.7

10 2008-09

2009-10

2010-11

2011-12

2012-13

2013-14

Chart 8.2 Proportion of NBFCs assets to bank assets (%)

2014-15

2015-16

2016-17

8.2 NBFCs Share of Deposits

97

3 2.6

2.6 2.4

2.5 2

2

1.9

1.9

1.9

1.5 1.1

1 0.6

0.5 0.1

0.5 0.2

0 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17

Chart 8.3 NBFC’s share of deposits in the financial savings of households

8.2 NBFCs Share of Deposits The NBFCs share of deposits in the financial savings of the households in India has been continuously increasing over time. In 2005–06, it was just 0.1%. In 2016–17, it increased to 1.9% (Chart 8.3). This clearly indicates the growing role of NBFCs in the financial savings of the households in India.

8.3 Credit Growth: Banks Versus NBFCs The NBFCs credit also grew more rapidly as compared to the banking sector and national housing finance institutions (Chart 8.4).1 However, the credit growth of NBFCs is highly volatile as compared to banks till 2011–12. High volatility of the NBFCs credit growth may be due to regulatory changes and positioning of strong prudential measures. After that, the growth is more or less volatile in both sectors.

8.4 Regional Coverage of NBFCs and Banking Sector The core strength of NBFCs lies in their sizeable presence in semi-urban and rural areas (Tier III and below locations) and their strong understanding of regional dynamics which enable them to build strong customer relationship. About 60% of their 1 According

to CRISIL (2014), the market share of NBFCs in the total credit system of the country was 14.7% in 2006–07 and it marginally increased to 15.7% in 2012–13.

98

8 Banks and NBFCs in India: A Comparative Analysis

35 30

29.9

25 20

29.3

27.9

20.9 22.9

22

21.8

21.2

19.9

15.3

18.1

15

21.1

18.9

15.9

14.5

11

10

10

12.7

9.7

5

6.9 2.8

0 2010-11

2011-12

2012-13 Banks

2013-14

NBFCS

2014-15

2015-16

2016-17

Housing Financing Companies

Chart 8.4 Credit growth in banks and NBFCs (%)

Chart 8.5 Rural and urban coverage of NBFCs and banking sector. Source CRISIL (2011)

business accrues from semi-urban and rural areas where retail finance penetration is low (Chart 8.5). The banks especially public sector banks, which have a significant presence in these areas, have remained largely focussed on mobilizing retail liabilities.

8.5 Share in Retail Finance by NBFC’s and Banks Over the past few years, there has been a decline in the growth rate of banking sector share towards total retail finance. This has resulted in a significant increase in the steady growth of retail financing by the NBFC sector. The NBFCs’ share in the retail finance increased from 26% in 2011–12 to 30% in 2016–17 (Chart 8.6).2

2 While

NBFCs have grown steadily over years, the retail market share of banks has recorded a subdued growth.

8.6 Infrastructure Financing by NBFCs Versus Banking Sector 74

80

73

73

72

99 72

70

70 60 50 40

27

26

30

28

27

28

30

20 10 0 2011-12

2012-13

2013-14

% Share of Banks

2014-15

2015-16

2016-17

% Share of NBFCs

Chart 8.6 Share in retail finance NBFCs vis-a-vis banks 10000 9000 8000 7000 6000 5000 4000 3000 2000 1000 0

9648

9245

9064

8364 7297 5913

5795

4978 3594

2012-13

4119

2013-14

2014-15 NBFCs

2015-16

2016-17

Banks

Chart 8.7 Lending to infrastructure sector NBFCs vis-a-vis banks

8.6 Infrastructure Financing by NBFCs Versus Banking Sector The quantum of infrastructure finance provided by the NBFC sector witnessed an annual growth rate of 12.7% during 2012–13 and 2016–17. In absolute terms, during the same period the NBFCs finance to infrastructure increased from |3594 billion to |5795 billion (Chart 8.7). Moreover, the NBFCs financial support to infrastructure sector accounted for 39% and the balance is accounted for banks.

8.7 Profitability of NBFCs and Banks Chart 8.8 provides a comparative picture on the profitability trends of NBFCs and banks. It uses trends of return on assets (ROA) of NBFCs and banking sector. The ROA of NBFCs sector is always on the higher side mainly due to its lower operating costs, and further, NBFCs do not have statutory pre-emptions like CRR. It is also

100

8 Banks and NBFCs in India: A Comparative Analysis 2.4

2.5

2.25 2.1

2.2

2.1 1.9

2

2.1

2.1

1.85 1.6

1.5

1.4

1.35 1.13

1.02

1.2 1.05

1.01

1.11 1.08

1

1.1

1

1 0.8

0.8

0.9

0.9

0.9

0.6 0.4

0.5

0.4

0 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 Banks

NBFCs

NHG

Chart 8.8 Trends in return on assets: NBFCs and banks

interesting to note that the return on assets of NBFCs has shown stability with figures ranging 1.85 and 2.4% over the years and is always higher than that for banks.

8.8 Risk Involvement of NBFCs-ND-SI in India The NBFCs-ND-SI constitutes about 80% of the total assets of NBFCs sector. The revised regulatory framework for the NBFCs raised the threshold asset size of the NBFCS-ND-SI to |5 billion or more. As a result, many of the NBFCs-ND-SI were reclassified as NBFCs-ND. The asset quality of NBFCs-ND-SI has deteriorated from 1.7% in 2011–12 to 6.1% in 2016–17 (Chart 8.9). This may be partially due to the changes in asset classification norms. 10

9.3

9 8

7.5 7

7

6.1

6 5

4.9

4.3

2

4.3

3.8

4 3

4.9 3.3

2.3

3.1 2.5

2.3

2.9 2.3

3.1

3 2.4

2.5

2.3

3.2 2.2

2.6

2.9

1.7

1 0 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 Banks NBFCs-ND-SI

Chart 8.9 NPA ratios of NBFCs-ND-SI and banks (%)

8.8 Risk Involvement of NBFCs-ND-SI in India

101

However, it is noticed that the NPA ratio of NBFCs-ND-SI was relatively low as compared to that of banks in India. Particularly in 2016–17, the NPA ratio of NBFCsND-SI was 6.1% while that of banks was 9.3%. Thus, under borrowers’ credit profile, the NBFCs have built-up their processes and systems to manage intrinsic risks.

8.9 Summing Up In the last seven or eight decades, India has both banks and NBFCs. Both have grown significantly and contributed to the development of India. In the process of financial deepening, the interlinkages between these institutions have strengthened. At the same time, the RBI has positioned enough regulations and supervisory standards to safeguard each one without affecting the other. This kind of happy coexistence in India is somewhat different from what we observed under ‘shadow banking’ in the advanced and other emerging market economies. Our analysis in this chapter indicates that the asset growth of NBFCs is impressive. The assets of NBFCs relative to GDP (i.e. asset ratio) increased from 8.4% in 2005–06 to 13% in 2016–17. During the same period, the asset ratio of banks improved from 75.4 to 93.2%. The proportion of NBFCs assets to bank assets has also steadily grown over the years, thus maintaining their growth momentum on par with banks and gaining the systemic importance. Their steady growth and increased market share indicate their success in their business models. Further evidences also clearly indicate (i) the growing role of NBFCs in the financial savings of the households in India; (ii) relatively fast credit growth of the NBFCs as compared to banks; (iii) their strong presence in the semi-urban and the rural areas and their strong customer relationship; (iv) their increased share in the retail finance over the years; (v) higher financial support to infrastructure sector relative to their assets of NBFCs compared to banks; (vi) higher profitability of NBFCs than that of banks; and (vii) relatively low NPA ratio of NBFCs as compared banks’ NPA.

Chapter 9

Non-banking Financial Intermediaries: International Experiences

9.1 Non-banking Financial Intermediaries The non-bank financial institutions or non-bank businesses or shadow banks (SBs) are internationally recognized as financial intermediaries/activities involved in “credit intermediation outside the conventional banking system and constitute about onefourth of total financial intermediaries worldwide” (IMF 2014). They, in general, refer to non-deposit-taking financial intermediaries only for current accounts. However, in some countries they refer also deposit-taking institutions like postal saving entities in Italy, Japan and USA. While the terms, non-banking financial companies (NBFCs) and non-banking financial institutions (NBFIs), are used interchangeably, they are in fact not the same. Basically, the NBFIs or non-banks include: money market funds, financial companies, structured financial vehicles, hedge funds, equity funds, fixed income funds, broker-dealers, real estate investment funds/trusts and trust companies (Shanmugam 2015). The term “NBFCs” is more suited to India as it includes companies that are registered under the Companies Act 1956 and also under Section 45 I(a) of the Reserve Bank of India Act 1934. As the term NBFIs is commonly used in many countries, this chapter uses this broader term. However, it is noticed that the Financial Stability Board (FSB 2012) defines the shadow banking as “credit intermediation involving entities and activities (fully or partially) outside the regular banking system”. The FSB in its “Global Shadow Monitoring Report 2012” used the term “other financial intermediaries” (OFIs), which include NBFIs except insurance companies, pension funds or public sector financial entities, as a conservative proxy for shadow banking. But in its 2015 report, the FSB (2015) changed the definition of “shadow banking”. It basically has used a new activity-based “economic function” measure of shadow banking. This new measure covers those non-bank credit intermediaries if their activities give rise to shadow

© Springer Nature Singapore Pte Ltd. 2019 R. Kannan et al., Non-Banking Financial Companies Role in India’s Development, India Studies in Business and Economics, https://doi.org/10.1007/978-981-13-3375-0_9

103

104

9 Non-banking Financial Intermediaries: International Experiences

banking risk in at least some jurisdictions. These are: (i) certain entities that are susceptible to runs (fixed income funds, hedge funds, real estate funds), (ii) market intermediation dependent on short-term funding or secured funding of client assets (broker-dealers), (iii) lending dependent on short-term funding (finance companies, leasing companies, consumer credit companies, factoring companies), (iv) facilitating credit creation (credit insurance companies, financial guarantors, monolines) and (v) securitization vehicles. Therefore, we use this alternative measure of shadow banks (SBs) also in this chapter. The NBFIs or SBs provide several forms of financial services globally and serve as competitors to banks and specialize in sectors/groups. They also complement banks by expanding access to credit. That is, they play a complementary role in the financial inclusion agenda in many nations by expanding credit to under-banked communities, sub-prime customers and low-rated firms or by supporting market liquidity, maturity transformation and risk sharing (Claessens et al. 2012). Due to their simplified sanction procedures, flexibility, timeliness in meeting the credit needs and low-cost operations, the NBFCs get an edge over their counterparts –banks in providing funding. Many cite that regulatory arbitrage is one of the reasons for the existence of NBFIs. The regulatory arbitrage has enabled them to offer financial products at cheaper prices than regulated banking institutions. Thus, by receiving more efficient services, customers and consumers get greater satisfaction. The positive role played by the NBFIs is also well documented in the literature. The available evidences in the financial literature suggest that (i) the financial institutions contribute strongly and positively to the economic growth; (ii) their contribution is enhanced if the intermediation is provided through a balanced combination of NBFIs and banks1 ; (iii) a multi-facet financial system which includes the NBFIs can protect economies from financial shocks; and (iv) the NBFIs play a significant role in achieving the financial inclusion objectives. While the NBFIs can contribute to the economy, they may bring some risks that vary depending upon the economic functions performed by them. Experts in the field believe that the only way to control these risks is through proper regulation. The NBFI regulation is generally underdeveloped in most countries. “Too little or no regulation can lead to crisis. On the other hand, too strict regulation can hinder innovation and development. Getting the right balance is a perpetual challenge for financial regulators and supervisors, not only in developing nations but also in developed and advanced nations” (Shanmugam 2015). The recent global financial crisis was a lesson and an eye-opener for stricter financial regulation around the world. It has brought to our notice that the NBFIs are a major source of systemic risk to the financial system through their significance as a source of credit and liquidity in the economy or their interconnectedness with regular banking system. It has also showed the failure of regulators and market participants 1 According to Shrestha (2007), “A well-developed non-bank financial sector is viewed as an impor-

tant component of a healthy and efficient financial system that can provide a sound base for growth and prosperity in the economy”. Studies such as Levine, Loayza and Beck (1999) empirically prove this.

9.1 Non-banking Financial Intermediaries

105

alike to fully understand the strength of the shadow banking system that exacerbated business and financial cycles in the financial system (Dudley 2009). Due to these lessons from the global financial crisis, the policymakers around the globe took increased initiatives to get a clear picture about the shadow banking system and to gather information in order to create a robust monitoring system. At the 2010 Seuol Summit, the G20 Leaders asked the Financial Stability Board along with other international bodies to compile required information on the non-banks and make suitable recommendations to strengthen the regulatory mechanism of the shadow banking system. Accordingly, the FSB (2011) published its first report “Shadow Banking: Scoping the Issues”. Subsequently, it brought out its second report “Global Shadow Banking Monitoring Report 2012” in November 2012. After that, every year, it publishes its Global Report. The latest report is: Global Shadow Banking Monitoring Report 2017 (FSB 2018), covering 29 nations (but this study excluded Cayman islands due to missing data) including 8 Euro nations. While the FSB (2018) collected data based on “Flow of Funds” from major 29 nations, it mostly provides aggregate level analysis in its report. This chapter utilizes the country-specific data from FSB (2018) and provides details on the size and structure of the shadow banking system (or NBFIs) and their role in the financial system of various countries. Specifically, this chapter reviews and analyses the following: • The overall size and growth trends of NBFIs across major global financial system during 2005–2016; • The nation-wise trend of NBFIs (or shadow banking) during 2005–2016; • The size and the composition NBFIs in 28 major nations in the world; • The degree of interconnectedness of NBFIs in various countries with banking system; and • The regulatory and the supervisory regime for NBFIs in major global financial systems. As stated earlier, the data on the new measure of shadow banking are available only from 2010, and we compute the growth rate of this variable during 2011–2016.

9.2 An Overview of Financial Systems of 28 Major Countries This section presents a systematic account of size, composition and trends of major global financial system.2 For this purpose, it uses the database compiled by FSB (2018) for its report “Global Shadow Banking Monitoring Report 2017” from 2 The financial system plays a major role in the smooth and efficient functioning of the economy. Its

major contribution is to channel resources from individuals and companies with surplus resources to those with resource deficits. In this process, the financial system satisfies the savings needs of the country and also facilitates the accumulation of investment capital that is critical to growth and

106

9 Non-banking Financial Intermediaries: International Experiences

28 major countries, namely Argentina, Australia, Belgium, Brazil, Canada, Chile, China, France, Germany, Hong Kong, India, Indonesia, Ireland, Italy, Japan, Korea, Luxembourg, Mexico, Netherland, Russia, Saudi Arabia, Singapore, South Arica, Spain, Switzerland, Turkey, UK and USA. Belgium, Germany, France, Italy, Netherlands, Luxembourg, Ireland and Spain constitute the Euro area. These nations jointly account for about 80% of World GDP and 90% of global financial system assets. Countries vary in terms of economic development which is measured in terms of per capita income (Table 9.1). The top three nations in terms of per capita figure (in 2016) are: Luxembourg (USD 101797), Switzerland (USD 80311) and Ireland (USD 64793). The poorest nations are: India (USD 1749), Indonesia (USD 3604) and South Africa (USD 5316). India’s per capita income is only 1.72% of Switzerland’s per capita income. Countries also vary in terms of the size of GDP. The USA ranks first with the nominal GDP of USD 18624 billion, followed by China (USD 11222 billion) and Japan (USD 4649 billion). The GDP of India is USD 2274 billion. The Euro area accounts for about 16.8% of total GDP (USD 63585 billion) of 28 jurisdictions. It is also noticed that there are considerable differences within Euro area in terms of stage of economic development. Germany has the largest GDP (USD 3479 billion) while Luxembourg has the lowest GDP (USD 59 billion). In terms of size of financial markets, USA (with USD 90422 billion) has the largest capital market among the 28 major nations, followed by China (USD 49127 billion) and Japan (USD 33548 billions).3 It is, however, noted that Luxembourg has the highest financial assets–GDP ratio (26107%) followed by Ireland (1668%) and Netherlands (14103%). The bottom three nations with low financial assets ratio are: Argentina (77.3%), Indonesia (88.9%) and Turkey (119%). The ratio is 146.9% in India. The Euro area accounts for nearly 23.9% of the total financial assets and its financial assets–GDP ratio is 752.7%. During 2005–16, the total financial assets (in current prices) grew at an average rate of 6.36%, and in Euro area, it grew only at 3.48% (Table 9.1). The respective growth rates in 2010 USD constant prices were: 4.5% and 3.1%. In USA, UK and China, the real financial assets grew at 2.7, 3.64 and 16%, respectively. However, it grew at 10.7% in India, 7.2% in Turkey, 10.1% in Brazil and 12% in Indonesia. Globally, banks and non-banks assets account for 67.5% of total financial assets. Banks’ size in 28 nations amounted to USD 133.6 trillion in 2016 and non-banks’ size to USD 93.0 trillion. Size of both banks and non-banks varied across nations. Banks’ size ranged from USD 166 billion in Argentina and USD 28969 billion in China in 2016 (Table 9.2). Relative to GDP, the banks’ assets was the largest in Luxembourg (1378%) in 2016 and was the lowest in Argentina (30%). In India, the banks’ asset was 79.6%

development. Further, it also revolves the risk preferences of individuals and companies (Carmichael and Pomerleano 1999). 3 The total financial assets comprise the assets of central banks, banks, insurance companies, pension funds, public financial institutions, financial auxiliaries and other financial intermediaries (or NBFIs).

9.2 An Overview of Financial Systems of 28 Major Countries

107

Table 9.1 Key economic and financial indicators of nations (2016) Country

Nominal GDP (USD billion)

Per capita GDP (USD)

Financial assets (USD billion)

Financial assets as % of GDP

GDP GDP (2010 US nominal Constant) growth growth (2005–2016)

Financial assets real growth (2005–2016)

Financial assets nominal growth (2005–2016)

Argentina

554

12,709

428

77.28

3.33

11.44

2.06

9.20

Australia

1265

51,873

5496

434.51

2.85

6.62

6.14

8.29

Belgium

468

8700

2564

547.67

1.31

2.25

1.19

2.05

Brazil

1793

41,388

4922

274.50

2.34

10.08

13.02

21.32

Canada

1536

42,418

10,065

655.38

1.80

3.89

5.57

7.25

Chile

250

13,743

730

292.02

3.80

8.62

5.80

10.20

China

10.20

11,222

8116

49,127

437.78

9.51

15.96

4.65

France

2466

38,205

14,781

599.29

0.97

1.59

4.32

4.89

Germany

3479

42,250

15,559

447.21

1.46

2.06

0.47

0.86

Hong Kong

321

43,497

3815

1188.94

3.69

5.52

8.47

10.38

India

2274

1749

3341

146.94

7.68

10.70

11.19

14.26

Indonesia

932

3604

829

88.90

5.59

12.01

5.48

11.41

Ireland

304

64,793

5078

1667.71

4.47

4.20

4.63

0.88

1860

30,662

7109

382.17

−0.21

0.59

16.97

19.20

Japan

4949

38,983

33,548

677.85

0.71

0.60

1.90

1.57

Korea

1411

27,535

5833

413.37

3.54

5.70

7.28

8.17

59

101,797

15,313

26107.29

2.79

4.89

9.07

10.73 6.70

Italy

Luxembourg Mexico

1077

8807

1291

119.83

2.31

3.25

6.40

778

45,658

10,960

1409.57

1.25

1.83

5.21

5.54

Russia

1281

8900

2487

194.07

2.78

9.37

8.73

7.69

Saudi Arabia

645

20,318

1433

222.14

3.91

8.93

8.69

13.30

Singapore

310

55,241

2673

863.01

5.50

8.98

5.96

9.45

South Africa

296

5316

1190

402.38

2.72

2.65

5.41

5.20

Spain

3.30

Netherlandsa

1238

26,677

4728

381.94

0.97

1.60

2.76

Switzerlanda

669

80,311

6322

945.33

1.98

4.76

4.91

7.30

Turkey

863

10,817

1031

119.36

5.38

7.16

37.00

42.11

UKa

2661

40,530

27,168

1021.10

1.44

1.21

3.61

3.28

USA

18,624

57,559

90,422

485.50

1.64

3.56

2.66

4.60

Total

63,585

932,155

336

0.53

3.05

4.56

4.50

6.36

Euro area

10,652

358,741

80,180

752.69

13.01

1.66

3.10

3.48

Source (Basic Data): FSB (2018) and World Bank Website: http://data.worldbank.org/indicator/N.Y.GBP.PCAP.CD a Due to non-availability of data, the average growth rates for these countries may not be for full period, but may be for less period

108

9 Non-banking Financial Intermediaries: International Experiences

Table 9.2 Size of banks and non-banks (NBFIs) in 2016 Country

Argentina

Banks assets (USD billion)

Banks assets as % of GDP

Banks assets as % of financial assets

NBFCs assets (USD billion)

NBFCs assets as % GDP

NBFCs assets as % of financial assets

166.1

29.97

38.78

36.0

6.49

8.40

Australia

2,787.8

220.39

50.72

743.1

58.75

13.52

Belgium

1,165.1

248.88

45.44

838.7

179.15

32.71

Brazil

1,910.2

106.53

38.81

1289.2

71.90

26.19

Canada

2,822.3

183.77

28.04

4675.1

304.42

46.45

Chile

274.1

109.62

37.54

159.8

63.93

21.89

China

28,969.0

258.15

58.97

9,563.8

85.23

19.47

France

8,297.4

336.41

56.13

2458.8

99.69

16.63

Germany

8,544.1

245.57

54.91

2756.1

79.21

17.71

Hong Kong

2,663.2

829.96

69.81

248.5

77.45

6.51

India

16.71

1,809.1

79.57

54.15

558.3

24.56

Indonesia

508.9

54.58

61.39

75.2

8.07

9.08

Ireland

622.3

204.36

12.25

3847.8

1263.66

75.77

Italy

3,631.5

195.23

51.08

1025.1

55.11

14.42

Japan

16,707.4

337.57

49.80

4372.1

88.34

13.03

Korea

2,636.8

186.87

45.21

1494.9

105.94

25.63

Luxembourg

808.1

1,377.71

5.28

14078.4

24,002.07

91.94

Mexico

423.6

39.34

32.83

231.9

21.54

17.97

Netherlands

2,365.8

304.26

21.59

6335.4

814.79

57.80

Russia

1,432.0

111.76

57.59

423.7

33.07

17.04

Saudi Arabia

601.4

93.26

41.98

32.2

4.99

2.25

1,740.9

562.01

65.12

282.3

91.15

10.56

349.5

118.22

29.38

245.4

82.98

20.62

Singapore South Africa Spain

2,656.6

214.63

56.19

852.9

68.90

18.04

Switzerland

2,431.8

363.64

38.47

1828.9

273.48

28.93

Turkey

735.9

85.24

71.41

80.1

9.28

7.77

UK

14,120.7

530.72

51.98

7370.9

277.03

27.13

USA

22,401.9

120.28

24.77

27124.1

145.64

30.00

Total

133,583.5

210.09

39.78

93028.8

146.31

27.70

31,220.0

293.08

38.94

32189.4

302.18

40.15

Euro area

Source (Basic Data): FSB (2018)

50 40 30

39.8 38.9

60

12.3

70

109

71.4 69.8 65.1 61.4 59.0 57.6 56.2 56.1 54.9 54.2 52.0 51.1 50.7 49.8 45.4 45.2 42.0 38.8 38.8 38.5 37.5 32.8 29.4 28.0 24.8 21.6

9.2 An Overview of Financial Systems of 28 Major Countries

5.3

20 10

Turkey Hong Kong Singapore Indonesia China Russia Spain France Germany India UK Italy Australia Japan Belgium Korea Saudi Arabia Brazil Argentina Switzerland Chile Mexico South Africa Canada USA Netherlands Ireland Luxembourg Total Euro Area

0

Chart 9.1 Share of banks in the total financial system assets (2016)

of GDP. In the following six countries, Argentina, India, Indonesia, Mexico, Saudi Arabia and Turkey, the banks’ asset–GDP ratio is less than 100% (Table 9.2). In 13 out of 28 nations, banks held about half of the financial system assets in 2016. Among these 13 nations, Turkey obtained first rank with banks’ share of 71.4%, followed by Hong Kong (69.8%) and Singapore (65.1%). Only in South Africa, Canada, USA, Netherlands, Ireland and Luxembourg, banks held less than 30% of total financial assets of the country. In India, the banks’ share was 54.2% (Chart 9.1). In terms of total assets, China’s banking system ranked first among 28 nations and USA and Japan ranked the second and the third, respectively (Table 9.2).

9.3 Development and Growth of NBFIs Across Jurisdictions While the global financial systems remain bank-dominated (with banks share of about 40%), the NBFIs hold 27.73% of the total financial system assets in 2016 (Chart 9.2). In Luxembourg, the NBFIs hold 91.9%, and in Ireland, they hold 75.89% of total financial assets. The NBFCs hold 40.1% in Euro area, 16.7% in India, 19.59% in China and about 2% of total financial assets in Saudi Arabia. The aggregate NBFIs asset in 28 nations relative to their total GDP was 145.64% in 2016. In absolute term, the total NBFIs assets amounted to USD 93029 billion. The USA had the largest NBFI sector, amounting to USD 27124 billion, a 29.2% of total NBFIs assets in the globe (Chart 9.3). Luxembourg had the second largest NBFIs sector, amounting to USD 14078 billion, a 15% share total, and the China had the

80.0

57.8

70.0

46.4

60.0 50.0 40.0 30.0 20.0 10.0

32.7 30.0 28.9 27.1 26.2 25.6 21.9 20.6 19.5 18.0 18.0 17.7 17.0 16.7 16.6 14.4 13.5 13.0 10.6 9.1 8.4 7.8 6.5 2.2 27.7 40.1

90.0

75.8

100.0

9 Non-banking Financial Intermediaries: International Experiences 91.9

110

Luxembourg Ireland Netherlands Canada Belgium USA Switzerland UK Brazil Korea Chile South Africa China Spain Mexico Germany Russia India France Italy Australia Japan Singapore Indonesia Argentina Turkey Hong Kong Saudi Arabia Total Euro Area

0.0

Chart 9.2 Share of NBFIs in the total financial system assets (2016) Spain, 0.92 Australia, 0.80India, 0.60 Russia, 0.46 Singapore, 0.30 South Africa, 0.26 Chile, 0.17 Italy, 1.10 Belgium, 0.90 Hong Kong , 0.27 Mexico, 0.25 Turkey, 0.09 Brazil, 1.39 Indonesia, 0.08 Korea, 1.61 ArgenƟna, 0.04 Switzerland, 1.97 Saudi Arabia, 0.03 France, 2.64 Germany, 2.96 USA, 29.16 Ireland, 4.14 Japan, 4.70

Canada, 5.03 Luxembourg, 15.13 Netherlands, 6.81 UK, 7.92

China, 10.28

Chart 9.3 Country’s share (%) in total NBFIs assets in 28 nations (2016)

third largest NBFIs sector amounting to USD 9564 billion, a 10.3% share. The Euro area with USD 32189 billion accounted for a 34.6% share. Combined together, the Euro area, USA and UK accounted for 71.7% of total global NBFIs assets in 2016. This compares with their modest share (58.2%) in terms of global banks assets. The NBFIs assets amount to USD 32.2 billion in Saudi Arabia and USD 36 billion in Argentina (Table 9.2). China and India are among 11 countries with 10–20% share of NBFIs (Chart 9.2). While the NBFIs in India hold assets worth of USD 538 billion,

9.3 Development and Growth of NBFIs Across Jurisdictions

111

its share in the total NBFIs asset in the globe is only 0.6% (Chart 9.3). It is interesting to note that in 10 other countries (Argentina, Chile, Hong Kong, Indonesia, Mexico, Russia, Saudi Arabia, Singapore, South Africa and Turkey), their share is less than 0.6%; i.e., their share is less than India’s share. During 2005–16, the aggregate NBFIs assets (nominal) of 28 nations grew at an average rate of 8, 15% per annum, and during 2011–16, it grew only at 5.13% (Table 9.3). It is noted that the definition of shadow banking provided by FSB (2015) and data on this measure were available since 2010. During 2005–16, Singapore registered the highest growth of 118.54%. The other top two nations with higher growth were Brazil (100.9%) and Russia (97.48%). India recorded 30.27% growth. In USA, Luxembourg and China, which are top nations in terms of larger quantum of NBFIs assets, the NBFIs’ asset grew at 3.78%, 12.46% and 11.77%, respectively. In Euro area, the growth rate was 5.54%. Composition of NBFIs: Table 9.4 depicts the shares of sub-sectors of NBFIs, namely money market funds, hedge funds, captive financial institutions and moneylenders, broker-dealers, financial companies, structured financial vehicles, real estate investment funds/trusts, trust companies and central counterparties.4 Investment funds are the largest sub-sector of NBFIs with a share of 37.6%. The total assets owned by this sector were USD 37.3 trillion in 2016. The second largest sub-sector is the capital financial institutions and moneylenders. Their assets amounted to USD 20.4 trillion in 2016, accounting for 20.5% of total NBFIs assets. The broker-dealers are the third largest with 9.2% share. Their assets reached almost USD 9.2 trillion. Structured finance vehicles’ assets amounted to USD 4.4 trillion, accounting for 4.5% (Table 9.4).

9.4 Interconnectedness Between Banks and NBFIs Systemic risks can spill over from the NBFIs to the banking sector and vice versa. This interconnectedness can take many forms which include direct and indirect linkages. These direct and indirect linkages can become channels of risk contagion during the periods of stress. These linkages can take many forms, including (i) direct exposures such as funding interdependence or being part of a credit intermediation chain and (ii) indirect exposures such as holding similar assets as collateral (FSB 2018). To get an understanding on the potential channels of contagion, let us have a closer look at the direct linkage between banks and NBFIs. According to FSB (2018), “Aggregated across jurisdictions, banks’ claims on NBFIs increased by $0.5 trillion to $6.3 trillion in 2016, or 5.6% of bank assets at

4 This

section is primarily based on FSB (2018).

112

9 Non-banking Financial Intermediaries: International Experiences

Table 9.3 Average annual growth of NBFIs assets and banks assets in % Country

NBFCs asset growth (2005–2016)

Banks assets growth (2005–2016)

NBFCs assets growth (2011–16)

Nominal

Nominal

Nominal

Real

Real

Real

Argentina

23.22

14.82

7.70

0.58

15.51

11.33

Australia

4.48

2.45

9.36

6.94

−2.43

0.01

5.67

4.76

0.00

−0.88

−2.85

−1.38

100.90

79.07

15.87

8.24

2.49

5.61

7.91

6.26

6.91

5.12

1.87

4.83

Chile

11.77

7.05

10.49

6.08

−0.09

1.18

China

11.77

6.18

10.49

4.76

−0.09

−2.31

France

12.30

11.27

3.50

2.89

−2.15

0.25

Belgium Brazil Canada

5.43

5.27

−1.40

−1.89

2.33

4.07

Hong Kong

19.40

17.47

9.48

7.57

9.89

6.76

India

30.27

26.53

13.09

10.04

7.82

9.44

Indonesia

15.63

8.81

11.98

6.12

6.11

7.69

7.48

11.50

−13.34

−10.21

6.51

8.29

−1.48

−0.10

−1.33

−0.20

−2.24

−0.21

Germany

Ireland Italy Japan

3.51

4.45

1.83

1.98

0.73

4.72

Korea

13.02

12.24

4.51

3.52

9.75

8.41

Luxembourg

12.46

10.82

−0.79

−2.64

11.39

13.05

Mexico

9.75

9.26

5.02

4.71

2.85

5.53

Netherlandsa

7.66

7.24

1.90

1.60

1.33

3.70

97.48

80.99

7.74

9.14

141.22

116.80

Russia Saudi Arabia

20.03

14.91

11.05

7.27

7.49

9.26

118.54

111.14

7.49

4.07

10.32

9.83

11.81

11.80

3.28

3.61

1.90

8.41

2.32

1.72

2.50

1.85

−8.40

−5.54

Switzerlanda

11.29

8.88

4.76

2.37

3.30

2.98

Turkey

Singapore South Africa Spain

11.51

11.15

9.84

9.59

3.03

7.50

UKa

5.87

6.16

2.59

2.88

−2.91

−2.40

USA

3.78

1.84

5.59

3.62

3.23

1.59

Total

8.15

6.33

5.99

4.03

5.13

5.47

Euro area

5.54

5.35

1.60

1.02

3.73

5.96

Source (Basic Data): FSB (2018) a Due to non-availability of data, the average growth rates for these countries may not be for full period, but may be for less period

9.4 Interconnectedness Between Banks and NBFIs Table 9.4 Composition of NBFIs (at end of 2016)

113

Sub-sectors

Size (2016) USD trillion)

% share

Growth (2011–15)

Total

99.2

100

Investment funds

37.3

37.6

12.9

Money market funds

5

5.1

4.9

Hedge funds

3.7

3.8

23.4

Captive financial institutions and moneylenders

20.4

20.5

11.7

Broker-dealers

9.2

9.3

1.3

Structured finance vehicles

4.4

4.5

−5.7

Finance companies

3.9

4

Real estate investment trusts and funds

1.9

1.9

12.4

Trust companies

3.4

3.4

32.1

Central counterparties

0.4

0.4

−5.9

9.3

0.2

Source (Basic Data): FSB (2018)

end-2016, while banks’ funding from NBFIs declined by $0.2 trillion to $5.9 trillion, resulting in a 5.4% bank use of funding from OFIs”. Banks Interconnectedness with NBFIs: Banks may have a direct connection with NBFIs from lending to or investment in NBFIs, from NBFIs’ providing wholesale funding, or custodian banks receiving the non-invested part of fund assets/operational deposits. Therefore, at the time of stress, both asset- and liability-side linkages may affect banks. Banks’ exposures to NBFIs were below 5% of total bank assets in most nations (Table 9.5). In most nations, banks’ use of funding from NBFIs was less than 10% of total bank assets, with few exceptions. In Brazil and Luxembourg, the bank funding is primarily from other investment funds, while in South Africa, it is primarily from MMFs and other investment funds. As bank funding from NBFIs is low or moderate

114

9 Non-banking Financial Intermediaries: International Experiences

Table 9.5 Interconnectedness between banks and NBFIs Country

NBFIs interconnectedness with banks, end-2016, per cent of NBFIs assets

Banks’ interconnectedness to NBFIs, end-2016, per cent of bank assets

NBFIs exposures to banks

Bank exposures to NBFIs

NBFIs use of funding from banks

Argentina

7.3

Australia

13.6

Belgium

3.6 26.4

0.2

Brazil

4.0

Bank use of funding from NBFIs

0.9

1.6

4.4

1.2

3.7

15.2

11.0

2.6

0.2

18.4

Canada

1.9

2.0

3.7

3.5

Cayman Islands

0.2

0.1

0.4

1.3

Chile

8.9

3.3

2.0

5.2

China

4.7

10.5

3.5

1.6

France

18.7

14.5

4.3

5.5

Germany

7.6

16.1

5.2

2.4

Hong Kong

0.0

31.7

3.0

0.0

India

11.8

29.2

9.0

3.6

Indonesia

14.2

20.3

3.1

2.1

Ireland

1.3

2.6

16.8

8.0

Italy

5.8

15.9

4.5

1.6

Korea

12.9

5.8

4.4

9.8

Luxembourg

1.2

0.2

3.6

20.3

Mexico

6.5

5.0

2.7

3.6 8.4

Netherlands

3.1

2.6

7.1

15.3

19.2

5.7

4.5

Saudi Arabia

3.4

14.9

0.8

0.2

South Africa

20.1

2.4

1.7

14.1

Spain

19.7

13.9

4.5

6.3

Switzerland

10.5

2.9

2.2

7.9

Turkey

1.2

12.8

1.4

0.1

UK

9.6

12.5

6.3

4.9

USA

3.4

3.0

4.9

5.5

Russia

Source FSB (2018)

9.4 Interconnectedness Between Banks and NBFIs

115

in most nations, funding exposures may also vary significantly across individual banks within each nation (FSB 2018). NBFI Interconnectedness with Banks: NBFIs’ interconnectedness with banks is the mirror image of banks’ interconnectedness with NBFIs. The NBFIs’ exposures to banks varied significantly across nations. It is noted that only in two nations, Brazil and South Africa, the NBFIs’ exposures to banks make up over 20% of total NBFIs assets (Table 9.5). The NBFIs’ funding from banks remains large in many countries. Table 9.5 shows that it is over 10% of total NBFIs assets in thirteen nations (Belgium, China, France, Germany, Hong Kong, India, Indonesia, Italy, Russia, Saudi Arabia, Spain, Turkey and UK), and in Belgium, Germany, Hong Kong, India, Indonesia, Italy and Russia, it is above 15% of total NBFI assets. Generally, this use of funding from banks may not in itself raise risks. The problem could arise when banks supply short-term funding to certain investment funds or leveraged the NBFIs (FSB 2018).

9.5 Size of Insurance and Pension Funds: A Note The insurance companies hold 8.55% of total financial assets while pension funds hold 9.2% (in 2016). USA (USD 8672 billion), Japan (USD 4143 billion), France (USD 2760 billion), UK (USD 2417 billion) and China (USD 2177 billion) are the top five nations with larger insurance companies’ assets. They jointly account for nearly 70.3% of the total global insurance companies’ assets (Table 9.6). The top five nations in larger pension funds assets are USA (USD 19096 billion), UK (USD 2610 billion), Australia (USD 1469 billion), Netherland (USD 1438 billion) and Canada (USD 1383 billion). These five nations jointly account for 84.13% of total pension funds assets in the globe. In India, the insurance companies hold 11.86% of total financial system assets in the county while the pension funds hold only 0.52%. During 2005–16, insurance companies’ assets (nominal) in India recorded an average annual rate of growth of 5.69% per annum while the pension funds registered an average rate of growth of 60.15% (which is the highest followed by China with 35.11% growth rate and Korea with 22.9%). Table 9.7 shows the size of shadow banks (SBs) assets in 28 nations (at end of 2016) and its growth during 2011–16. In USA, the NBFIs share in the total financial assets was 30% in 2016. Due to the narrow measure of definition, its share was 15.5%. Similarly in all countries, the share of shadow banking is less than the share of NBFIs. The growth of shadow banking assets (nominal) during 2011–16 was more than 40% in Argentina and China. In India, the SBs assets (nominal) grew at 13.7%.

116

9 Non-banking Financial Intermediaries: International Experiences

Table 9.6 Size of insurance companies and pension funds (2016) Country

Insurance companies assets USD billion (2016)

% of total assets

Pension funds assets Nominal growth % (2005–16)

Real growth (2005–16)

USD billion (2016)

% of total assets

Nominal growth % (2005–16)

Real growth (2005–16)

Argentina

18.1

4.23

5.99

2.62

55.0

12.83

3.64

0.48

Australia

292.0

5.31

−3.66

−1.91

1468.9

26.73

3.83

6.24

Belgium

8.01

331.2

12.92

0.22

1.97

26.2

1.02

6.26

Brazil

55.3

1.12

−3.31

−0.32

465.7

9.46

3.52

6.16

Canada

676.2

6.72

1.52

4.27

1382.8

13.74

2.72

5.66

Chile

58.6

8.02

3.41

4.72

184.1

25.21

3.66

4.99

China

2176.8

4.43

19.12

15.92

156.9

0.32

35.11

31.14

n.a

n.a

France

2760.1

18.67

1.71

4.09

Germany

2102.3

13.51

1.12

2.62

602.6

3.87

4.33

6.08

Hong Kong

307.1

8.05

15.02

11.75

123.1

3.23

7.93

4.89

India

396.1

11.86

5.69

7.19

17.4

0.52

60.15

62.70

41.8

5.04

8.65

10.46

18.9

2.28

5.51

7.27

289.3

5.70

−0.56

0.94

123.1

2.42

4.24

5.84

Indonesia Ireland

n.a

n.a

Italy

854.1

12.01

1.68

4.08

100.4

1.41

6.87

8.92

Japan

4144.8

12.35

−1.98

1.35

1351.7

4.03

−3.80

−0.55

Korea

922.7

15.82

10.27

8.85

133.9

2.30

22.93

21.22

Luxembourg

193.4

1.26

3.40

4.93

2.0

0.01

9.69

10.98

65.9

5.10

3.61

6.31

166.8

12.92

2.30

4.89

516.0

4.71

−0.73

1.52

1434.7

13.09

5.54

7.96

Russia

30.7

1.23

2.94

7.40

56.6

2.28

15.89

20.71

Saudi Arabia

15.3

1.07

12.10

14.09

n.a

n.a

Mexico Netherlandsa

n.a

n.a

Singapore

155.7

5.83

5.10

4.50

241.0

9.02

7.11

8.29

South Africa

217.5

18.28

−0.30

6.05

170.7

14.35

−1.62

4.64

Spain

328.1

6.94

0.22

3.21

140.9

2.98

0.14

3.20

Switzerlanda

589.6

9.33

2.13

1.72

739.4

11.70

3.68

3.36

16.6

1.61

2.33

6.79

17.3

1.67

15.97

21.06

Turkey UK

2416.9

8.90

−0.82

−0.34

2609.9

9.61

4.81

5.46

USA

8672.0

9.59

3.80

2.15

19095.8

21.12

4.67

3.01

Total

28.7

8.55

2.26

2.55

30.9

9.20

4.12

4.43

7735.6

9.65

1.27

3.36

2515.1

3.14

4.46

6.49

Euro area

Source (Basic Data): FSB (2018) a Due to non-availability of data, the average growth rates for these countries may not be for full period, but may be for less period

9.5 Size of Insurance and Pension Funds: A Note

117

Table 9.7 Size of shadow banks and their growth Country

NBFIs as % of financial assets (2016)

Shadow banking as % of financial assets

Growth of shadow banking assets (2011–16)

GDP growth

Argentina

8.4

7.6

44.5

29.9

Australia

13.5

6.2

1.9

3.1

Belgium

32.7

5.2

−4.8

2.1

Brazil

26.2

15.5

15.0

7.4

Canada

46.4

13.7

11.9

2.8

Cayman Islands

85.4

61.8

15.6

2.4

Chile

21.9

8.6

11.8

6.5

China

19.5

14.3

40.1

7.7

France

16.6

9.3

0.2

1.6

Germany

17.7

11.0

9.7

3.1

6.5

2.2

21.5

5.2

16.7

12.8

13.7

11.7

Hong Kong India Indonesia

9.1

1.9

11.3

9.6

Ireland

75.8

46.2

9.7

9.9

Italy

14.4

6.9

2.0

0.4

Japan

13.0

8.2

6.9

1.8

Korea

25.6

11.5

12.0

4.2

Luxembourg

91.9

21.2

10.9

4.7

Mexico

18.0

12.0

8.4

6.1

Netherlands

57.8

4.7

3.3

1.8

Russia

17.0

3.1

5.7

4.2

2.2

2.2

10.3

−0.8

Singapore

10.6

0.8

5.5

3.4

South Africa

20.6

13.5

14.4

7.5

Spain

18.0

6.5

3.7

0.8

Switzerland

28.9

11.4

6.1

1.2 13.3

Saudi Arabia

Turkey

7.8

4.9

16.9

UK

26.2

5.4

5.7

3.6

USA

30.0

15.6

0.2

3.7

Source FSB (2018)

118

9 Non-banking Financial Intermediaries: International Experiences

Table 9.8 Correlation of NBFIs assets with other indicators Indicators

Nominal GDP 2016

Per capita GDP 2016

Banks assets 2016

Shadow banking assets (2016)

Bank asset growth (2005–16) nominal

Bank asset growth (2005–16) real

NBFCs assets (2016)

0.81

0.46

0.65

0.93

−0.19

−0.23

Shadow banking assets (2016)

0.95

0.28

0.78

1.00

−0.10

−0.15

9.6 Relationship Between Development of NBFIs, Banks and Growth This section analyses the relationship between the development of NBFIs (SBs), banks and growth of economy in 28 major nations. Both NBFIs assets and SBs assets (at end-2016) are positively correlated with GDP, per capita income and banks assets (Table 9.8). They are negatively associated with banks’ assets growth (both nominal and real) during 2005–16, indicating that the higher growth of banks assets in these 28 nations leads to low quantum of NBFIs (SBs) assets. But in 2016, the NBFIs (SBs) assets and banks assets are positively related and complementing each other. Table 9.9 presents the regression results. The dependent variable is either NBFIs assets or SBs assets of 28 nations in 2016. The explanatory variables are: GDP, banks asset or banks assets growth (during 2005–14). The GDP is positively and significantly influencing both NBFIs assets and SBs assets. A one unit (=USD 1 billion) increase in GDP, on an average, leads to USD 1.5277 (1.2132) billion increase in NBFIs assets (in different specifications) and USD 0.8378 (0.7133) billion increase in SBs assets (in different specifications). The results also indicate that 1% increase in banks’ assets average annual growth (during 2005–14) lead to USD 305 billion decrease in NBFIs assets (in 2016) and USD 134.4 billion decrease in SBs assets. Interestingly, these results are strongly supported by t values.

9.7 Regulatory Regime for NBFIs Across Nations Regulations are fundamentally rules of behaviour and about the promotion of economic efficiency. Financial regulations are rules that govern commercial behaviour in the financial system. Herring and Santomero (1999) identify four broad rationales for financial regulations: (i) safeguarding the system against systemic risk; (ii) protecting customers against opportunistic behaviour by suppliers of financial services;

9.7 Regulatory Regime for NBFIs Across Nations

119

Table 9.9 Determinants of NBFIs/SBs assets of 26 major countries (in 2016) Variables

NBFIs assets

Constant

2073.6184 (2.355)

1777.0027 (2.091)

SBs assets 386.8943 (1.903)

269.4628 (1.306)

GDP

1.5277 (4.921)

1.2132 (7.692)

0.8378 (11.689)

0.7133 (18.634)

Banks assets

−0.1956 (−1.1731)

– –

−0.0774 (−2.012)

Banks assets growth

−365.0652 (−2.578)

−343.0308 (−2.426)

−134.44 (−4.113)

−125.716 (−3.663)

R-square

0.734

0.718,268

0.94385

0.93438

N (sample size)

28

28

28

28

(iii) enhancing the efficiency of the financial system; and (iv) achieving a range of social obligations. They also argue that market failure and its impact on economic efficiency justify the regulatory intervention.5 The cost of failure, in general, is greater than any costs imposed by regulation. Now let us review briefly the functioning of NBFCs and their regulations in selective nations. (i) USA: In USA, the NBFIs are all financial institutions that do not accept demand deposit and/or do not offer commercial loans. They are classified as: (i) deposit-type NBFIs, (ii) contractual-type NBFIs, (iii) investment-type NBFIs, (iv) finance companies and (v) others. These NBFIs are regulated by the Depository Institutions Deregulation and Monetary Control Act of 1980. This Act requires that the NBFIs should maintain reserve requirements in the form of vault cash or non-interest bearing deposits in the Federal Reserve System (FRS). Due to the Securities Exchange Act 1934, the companies must register as broker-dealers. The Investment Company Act, 1990, requires the registration of all non-exempt companies with the Securities Exchange Commission. (ii) UK: In UK, a separate legislation and self-regulatory organisation (SRO) regulate the NBFIs. The Financial Services Act (1986) and the Banking Act (1987) regulate deposit-taking and investment businesses. The Bank of England (BOE) acts as the supervisory and regulatory body for deposit-taking institutions. It has the power to call for an up-to-date and accurate prudential information. The Finance Services Act allows only authorized persons or entities to carry on investment businesses. Undertaking business without authorization or exemption is a criminal offence in UK. (iii) Netherlands: The NBFIs include various special financial institutions (SFIs), which comprise about two-third of NBFIs. The foreign multinationals own 5 The

financial markets fail to produce efficient competitive outcomes for one or more of the following reasons: (i) anticompetitive behaviour, (ii) market misconduct, (iii) information asymmetry and (iv) systemic instability.

120

(iv)

(v)

(vi)

(vii)

6 There

9 Non-banking Financial Intermediaries: International Experiences

more than 14,000 SFIs. About 80% of SFIs are part of non financial groups like oil companies, the telecom or the pharmaceutical companies in Netherlands. These are not involved with financial intermediation-let alone credit intermediation. These SFIs are not subjected to financial supervision. Australia: In Australia, building societies and credit unions constitute the major segment of NBFIs.6 Until 1992, the Reserve Bank of Australia regulated these institutions. After that, the Financial Institutions Legislation and a scheme of prudential supervision known as Financial Institution Scheme were introduced to regulate them. Other NBFIs are not prudentially regulated, but they are allowed to carry out credit intermediation. There are about 100 finance companies (FSB 2014a). Australian Securities and Investment Commission regulate the finance companies, financial markets and financial services organizations, deposit taking and credit (Raj Kumar 2014). China: In China, many institutions and activities outside the regular banking system engaged in credit intermediation.7 These finance companies are subjected to bank-like regulations and are not categorized as NBFIs. France: As per the French Banking Act, 1984, all credit institutions need to get authorization from the French Banking system before starting their operations. Depending on the area of specialization, these finance companies are classified into various groups such as consumer credit, real estate financing, equipment leasing and real estate leasing factoring. Without authorization from Banking Regulatory Committee, the financial companies and specialized financial institutions are not allowed to receive funds from public (Akhan 2010). Indonesia: Insurance companies comprise the largest non-bank intermediary in Indonesia. More than 50% of assets of insurance companies are held by five government-owned social insurance companies. Since 1988, insurance premiums have been de-regulated and left to market forces. However, prudential regulatory requirements for life insurance were established in the 1990s. Besides insurance, there are larger numbers of finance companies.8 The financial company has to be a limited liability company. All financial institutions are obliged to have a license from the Government and are not allowed to draw funds from the public. Further, there are restrictions on the amount of loan raised by them. However, finance companies engaged in the securities trading business are precluded from engaging in other types of operations. The Ministry of Finance along with Bank of Indonesia supervises them (Akhan 2010). As the majority of NBFIs are involved in maturity transformation and leverage and credit risk transfers are not subjected to prudential supervision and regulation, the failure or distress would create systemic risk.

are 20 brokerage companies. would obviously create systematic risks or regulatory arbitrage. 8 There are about 200 finance companies, 32 money market funds and 57 brokerage companies in Indonesia. 7 This

9.7 Regulatory Regime for NBFIs Across Nations

121

(viii) Singapore: Finance Companies Act, administrated by Monitory Authority of Singapore (MAS), governs the finance companies.9 It allows the finance companies to do only the financial activities and not any kind of other business. In fact, it does not also allow them to accept any deposit that is repayable on demand, or by cheque, draft or order drawn by a depositor on the finance company. The Act also stipulates the (i) minimum capital requirements of US $50 million, (ii) capital ratio of not less than 12%, (iii) maintenance of a reserve fund, (iv) transfer a prescribed amount to that fund out of net profits of each other and (v) maintaining of adequate provisions for bad and doubtful debts. (ix) The Philippines: As the NBFIs in The Philippines provide credit facility and financing outside the regular banking system, they are therefore not subjected to the same level of regulating and supervising requirements as banks. There are about 580 finance companies and many credit unions, microfinance institutions and brokerage activities. Collective investment schemes in Philippines involve investment in debt and equity securities only. They are not fund-raising schemes (FSB 2014a). (x) Thailand: The financing companies in Thailand are regulated under the Act on the Undertaking of Finance Business, Securities Business and Credit Finance Business, 1979. Prudential control measures relating to capital adequacy ratio, liquidity ratio, single lending limits, portfolio investment limits and disclosure requirements under this Act are equal to international best practices (Akhan 2010). The Bank of Thailand regulates and supervises the finance companies. Many financial investment business entities exist in Thailand. There are 1272 collective investment schemes, about 30 finance companies, 40 money market funds and 43 brokerage companies. Mortgage corporations and money market funds are also considered as NBFIs in Thailand. (xi) Hong Kong: The Hong Kong Monetary Authority supervises all authorized institutions: licensed banks, restricted licensed banks and deposit-taking companies. While the licensed banks are allowed to both retail and wholesale banking business, the restricted licensed banks are allowed to take time deposits from public without any restriction on maturity. The deposit-taking companies are however allowed to take deposits, not exceeding US $1,00,000. These companies are mostly owned/associated with banks. They are engaged in consumer finance, trade finance and securities business. (xii) Malaysia: The Banking and Financial Institutions Act 1989 governs all licensed commercial banks, finance companies and merchant banks in Malaysia. The finance companies specialize in consumption credit comprising hire purchase finance, leasing finance, housing loans and personal loans.10 Regarding the financial institutions, there are two-tier regulatory systems. The 9 Structured

finance vehicles (SFVs) are the largest sector in Singapore. They are considered as shadow banking or NBFIs only to the extent that they intermediate credit (FSB 2014a). 10 Malaysia has the largest number of financial companies; most of them are credit specialized companies including credit card companies.

122

(xiii)

(xiv)

(xv)

(xvi)

9 Non-banking Financial Intermediaries: International Experiences

Tier I institutions with larger capital base satisfy the minimum criteria set by Bank Negara Malaysia. These companies are allowed to operate in a more liberal regulatory environment. Building societies in Malaysia are treated as shadow banking as they are involved in maturity/liquidity transformation, leverage and primarily funded by short-term deposits. They are not subjected to any formal prudential oversight. The public financial institutions are the largest component of Malaysia’s NBFIs, accounting for about 40% of total assets of NBFIs in that country. Korea: There are 55 insurance companies, 5 public financial institutions, 9864 collective investment schemes (i.e. financial investment business entities), 3759 credit unions and cooperatives (CUCs), 156 money market funds, 65 finance companies, and 62 brokerage companies in Korea (FSB 2014a). The brokerage companies are classified as shadow banking because they undertake a host of economic functions and display certain systemic risk. The finance companies are also treated as shadow banking as they use to a large extent the leverage as the amount of funding from liabilities (such as bonds or loans). The collective investment schemes (CIS) are also treated as shadow banking as they undertake financial intermediation activities mainly through investment in beneficiary certificates. They are vulnerable to redemption risks. The CUCs basically manage the client cash and provide loans that rely on short-term financing. They are, however, not considered as shadow banking because of the fact that they raise funds (and deposits) mainly from their members and offer loans to them. The mortgage corporations are also not considered as shadow banks because they are public financial institutions guaranteed by the government. Japan: There are 65 insurance companies, 10 public financial institutions (PFIs), 86 CIS, 2259 finance companies, 443 CUCs, 282 brokerage companies in Japan. The CUCs conduct banking business and are subjected to the same prudential framework as banks, which effectively address risks. Therefore, they are not considered as shadow banks. The brokerage companies are treated as shadow banking. The finance companies are treated as shadow banking as they provide loans that rely mainly on short-term financing. The Japanese Diet passed the amendment bill on June 2013 to allow managers of Japanese Money Market Funds to compensate the losses. New Zealand: In New Zealand, the CUCs, the finance companies and the building societies are not treated as shadow banks despite their involvement in maturity and liquidity transformation. For prudential purposes, they are treated as part of the traditional banking sector. Thus, they are subjected to the same prudential framework as banks. However, New Zealand plans to introduce a new legislation to enhance the regulation of non-bank deposit takers and this will enable the Reserve Bank of New Zealand to implement a licensing regime for NBFIs. Switzerland: The Swiss NBFIs sector consists of (i) MMFs, (ii) bond funds, (iii) equity funds, (iv) other investment funds, (v) central mortgage bank institution and (vi) others which include financial companies, holding companies,

9.7 Regulatory Regime for NBFIs Across Nations

123

etc. The MMFs are not involved in considerable maturity transformation and allowed to invest only in highly liquid assets, and they do not promise fixed returns. Central mortgage banks provide long-term loans to banks, and they are prudentially supervised by Swiss Financial Market Supervising Authority (FMSA) which also supervises bond funds and all other investment funds (FSB 2014).

9.8 Summing Up The NBFIs play a vital role in the credit chain in most countries by filling credit voids not covered by other financial intermediaries. Strong NBFI sectors have been associated with strong financial and economic development. In general, the NBFIs regulation is generally underdeveloped in most nations. Further, the existing structure of regulations of NBFIs differs widely among the nations. However, there has been a shift in the recent years towards more integrated supervision with all banking, insurance and capital market being regulated by a single organization. The Financial Services Authority in UK is an example of integrated supervision while the twin regulatory bodies ASIC and APRO in Australia form a prudential and market conduct function, respectively. In most nations, the NFBIs or financial companies are not allowed to raise deposits from the public. But in few nations including India, Mexico, Singapore and UK where certain types of NBFCs are allowed to accept deposits. Broadly, there are three main approaches to regulate NBFCs in various nations: (i) NBFCs must obtain a license from a business conduct bureau and comply with consumer protection rules; (ii) as the NBFCs in a few nations often raise funds in capital markets and via debt issuance, those nations have additional investor protection regulation; and (iii) in a few other nations, bank-like prudential regulations are used (FSB 2012).11 In general, the Asian countries do not face the same level of shadow banking risks as in USA or UK, because Asia is relatively less developed financial markets and offers less complex financial products. Further, the Asian countries’ scale on nonbank sectors remains small in size and non-systemic in nature. While the most nations do not have specific policy instruments for dealing with systemic risks associated with NBFCs, they, however, have used policy tools derived from the general regulatory regime (e.g., consumer protection rule for NBFCs will have an indirect effect in addressing systemic risks by imposing limits on certain activities or types of risks). Some nations use prudential tools provided for banks (FSB 2012). Some other nations use macro-prudential framework in addressing the build-up of systemic risks of NBFCs. For instances, (i) Reserve Bank of Australia (RBA) uses annual monitoring exercise of shadow banking institutions including NBFCs to highlight any risks to the Council of Financial Regulations for policy actions; (ii) Canadian gov11 In some nations, there is sub-national regulation (e.g. provinces in Canada, states in USA) or sub-national supervision (e.g. prefectures in Japan) for NBFCs.

124

9 Non-banking Financial Intermediaries: International Experiences

ernment determines which mortgage quality for government insurance, thus limiting the activities in securitization markets; and (iii) The Financial Stability Oversight Council in USA requires the Federal Reserve to regulate NBFCs that are deemed to be “systematically important” based on the Dodd–Frank Act (Shanmugam 2015). As the NBFIs average annual growth was faster in countries like China and India during 2005–14 and low in many advanced nations like USA, UK and Euro nations, this trend indicated the convergence of assets of NBFIs across nations. Developing nations like India need to use this opportunity and ensure further and faster growth of NBFIs assets so that these NBFIS will complement banks and will be useful to bring more financial inclusions.

Chapter 10

Conclusions and Recommendations

The most significant insights and recommendations of the study are set out in this chapter.

10.1 Where NBFCs Stand Today Small/medium NBFCs doing well, but face higher interest rate risk: Our analysis indicates many small- and medium-sized NBFCs are doing well and have strong balance sheets, while some big ones are not doing well and pose a risk to the system. Our analysis also reveals that interest rate risk is more pronounced for small NBFCs than for big ones. Action point: While size matters, the RBI may consider some balance sheet ratios that truly exhibit the strength of the NBFCs and allow them to enjoy benefits. As the apex bank has already spelt out various risk management procedures for NBFCs, it may be time to move towards the calculation of economic capital. NBFCs play a significant role in supporting production: The contribution of NBFCs in providing credit to the production sector is well-recognized. They also lend to sectors that support the production sector, through transport finance, infrastructure finance, etc. Action point: The RBI may consider easing securitization of assets of these sectors, and lowering the capital requirements and provisioning norms, on a par with similarly placed financial institutions. Shadow banking a double-edged sword: Shadow banking activities undertaken by NBFIs and NBFCs facilitate inclusive growth. Besides, NBFCs have a great opportunity to work on financial product arbitrage of MSMEs where banks are not strong, thereby providing the possibility of securitization.

© Springer Nature Singapore Pte Ltd. 2019 R. Kannan et al., Non-Banking Financial Companies Role in India’s Development, India Studies in Business and Economics, https://doi.org/10.1007/978-981-13-3375-0_10

125

126

10 Conclusions and Recommendations

NBFCs can succeed in their role as enablers for effective cost control through process innovation, strong risk management framework, well-defined product policy guidelines, robust approach in credit assessment methodology, product approval and monitoring mechanism, risk-based pricing to tap value enhancement opportunity, monitoring, exception handling, collection, etc., when already inbuilt in the system. Among various sources, borrowings through NCDs constitute the largest source of finance for the NBFC sector, at ~30%. Since March 2010, funds raised through NCDs have witnessed phenomenal growth, led by infrastructure finance companies and gold loan NBFCs. NBFCs also play a very significant role in dealing with population segments which banks do not reach. They also provide competition to banks in delivery of financial services and thus create conditions for improved consumer orientation and efficiency of the entire system. On the flipside, shadow banking activities by NBFCs create risks, which can assume a systemic dimension. This is owing to the complex and cross-jurisdictional nature of such activities and their interconnectedness with the formal banking system. One of the main risks faced by shadow banks is liquidity risk, owing to asset–liability mismatch as these entities mature. By funding long-term assets with short-term liabilities, there is a possible risk of shadow banks becoming highly leveraged, as they do not usually have prudential limits on borrowings. Action point: Given the pros and cons, the RBI needs to develop a proper policy framework to address systemic risks while recognizing NBFCs for their contribution to inclusive growth. NBFCs have successfully leveraged the banking correspondent model: We have observed that the spread of business for NBFCs, fast credit disbursal methods and the low level of NPAs (compared with banks) were achievements made possible because of the banking correspondent model followed by NBFCs. However, it is surprising to note that the banking sector has ignored the role and expertise available with NBFCs in this regard. Action point: Banks could use NBFCs in addition to other methods in order to strengthen financial inclusion for the entire financial sector. This would produce durable results. NBFCs’ deepening reach accompanied by cleaner growth, stronger linkages with banks: Our analysis indicates (i) growing role of NBFCs in financial savings of households in India; (ii) faster credit growth of NBFCs compared with banks; (iii) NBFCs’ strong presence in semi-urban and rural areas and their strong customer relationship; (iv) their increased share in retail finance over the years; (v) higher financial support to infrastructure sector relative to assets by NBFCs compared with banks; (vi) higher profitability of NBFCs compared with banks; and (vii) relatively low non-performing assets (NPA) ratio of NBFCs compared with banks. Action point: In the process of financial deepening, interlinkages between banks and NBFCs have grown strong. At the same time, the concern of contagion is wellrecognized by the RBI, which has regulations and supervisory standards erected to safeguard each one without affecting the other. This kind of happy coexistence

10.1 Where NBFCs Stand Today

127

in India is somewhat different from what we observe under “shadow banking” in advanced and other emerging market economies. International comparison reveals convergence of NBFI assets across countries: Globally, NBFIs play an important role in the credit chain by filling voids not covered by other financial intermediaries. Strong NBFI sectors have been associated with strong financial and economic development. NBFI regulation is generally underdeveloped in most nations and there are variations across them. NBFIs are not allowed to raise deposits from the public in most nations, though a few, including India, Mexico, Singapore and the UK, allow certain types of NBFCs to do so. Broadly, there are three approaches to regulate NBFCs globally: (i) they must obtain a licence from a business conduct bureau and comply with consumer protection rules (such as caps on interest rates charged to customers); (ii) in nations where NBFCs raise funds in capital markets and via debt issuance, they have additional investor protection regulations; and (iii) bank-like prudential regulations are used in some nations (FSB 2012). Asian countries, in general, do not face the same shadow banking risks as other jurisdictions such as the USA or UK, because Asia has relatively less developed financial markets, less complex financial products, smaller scale and non-systemic nature of non-bank sectors. They do not have policy instruments that are especially designed for dealing with systemic risks associated with NBFCs; they use policy tools derived from the general regulatory regime. A few countries rely on prudential tools provided for banks. Some use macro-prudential framework to address build-up of systemic risks of NBFCs. Action point: NBFIs’ average annual growth was faster in countries such as China and India between fiscals 2005 and 2014, and low in many advanced nations such as the USA, the UK, and in Europe, indicating convergence of assets of NBFIs across nations. Developing nations such as India need to use this opportunity and ensure further and faster growth of NBFI assets so that they complement banks and further the cause of financial inclusion. NBFCs have ample scope to cash in on banking woes, growing demand: The ongoing stress in the banking sector, particularly public sector banks, owing to mounting bad debt, is likely to diminish their appetite to lend especially in rural areas. Besides, the consumer finance segment is expected to see healthy growth, driven by higher disposable incomes through increased effectiveness of government schemes and the Seventh Pay Commission. On the SME front, business and professional loans are on the growth trajectory. A PwC report (2016) also indicates strong urban demand and an increase in credit penetration will continue to drive growth in the consumer finance segment, though there may be a period of muted growth from the rural sector. Overall, NBFCs grew at a robust compound annual growth rate (CAGR) of 19–22% in retail credit to reach AUM of ~Rs. 6.044 trillion by 31 March 2017.

128

10 Conclusions and Recommendations

Action point: Banks’ lack of appetite provides NBFCs a window of opportunity to increase their presence and offer products in demand. It is also unlikely that safety aspects of lending are sacrificed by them, as all prudential ratios of NBFCs are within the acceptable safe limits. Banks have, after all, learnt the ropes of some credit businesses such as gold loans and truck loans from NBFCs.

10.2 Mooting a Roadmap for NBFCs Does the RBI have a long-term vision for NBFCs? Despite the existence of NBFCs for the past 80 years, the answer to this question is not quite clear. A critical examination of the recommendations of various committees appointed by the RBI and the GOI shows they are ad hoc in nature and do not provide a concrete roadmap. This study analyzes the NBFCs contribution to the economy, critically evaluates the issues faced by them based on various parameters and finally makes recommendations so that NBFCs can be placed on a firm footing in a level playing field. In the following sections, we first examine each of these positive contributions and then weigh them against the existing regulatory concerns, paving way for the recommendations.

10.3 Assessing NBFCs’ Strengths Asset financing, especially of vulnerable population: The role of NBFCs in financing motor vehicles, automobiles, etc., is well-established. Through asset financing, they also contribute to employment creation, especially in the rural and semi-urban areas of India. Indeed, NBFCs are known to have pioneered these concepts in many of these areas, with commercial banks picking up the threads. The credit culture that commercial banks are talking of now has been followed by major NBFCs for years. For example, the practice of checking ‘credit history’ in credit appraisal forms has been in vogue among NBFCs for years. The important point to underscore here is the role played by NBFCs in asset creation of vulnerable sections of the population who have been denied credit by commercial banks for many reasons. Lending to Infrastructure The Rakesh Mohan Committee Report of 1996 detailed the huge funding requirement for infrastructure, which is met partly by long-term financial institutions. Banks are challenged by asset–liability management issues and constrained by prudential limits imposed by the RBI from funding more. Their total exposure to infrastructure was Rs. 9 trillion at the end of fiscal 2017, or ~13% of their total non-food credit.

10.3 Assessing NBFCs’ Strengths

129

NBFCs have an outstanding exposure of Rs. 5.795 trillion to the infrastructure sector. Given the demand for infrastructure funds, NBFCs are seen playing an important supporting role. This has to be duly recognized and nurtured so that their contribution to infrastructure funding does not diminish. There is also a need to put in place proper risk mitigation techniques, credit rating, greater transparency, etc. Financial Inclusion It is widely recognized that banks in India have failed to meet the credit needs of a significant proportion of population who do not have a credit history. The creation of ‘regional rural banks’ and ‘local area banks’ clearly testifies to the failure of the banking system to meet the financial requirements of vulnerable sections in rural and semi-urban areas. On the other hand, if we look back at how asset financing NBFCs financed truck operators in the early 1940s/1950s, it is interesting to note how they played a significant role in financing specialized vehicles, viz. used trucks, used passenger vehicles, consumer durables loans. Indeed, the banking sector has drawn from these pages of NBFCs to carve out their own presence in these fields subsequently. Not only this, NBFCs have helped bring down the cost of borrowing in these areas, where people were dependent on moneylenders for finance at high/exorbitant interest rates. With the shift from moneylenders to NBFCs, interest cost for these sectors dropped. Thus, NBFCs have had a vital role to play in achieving financial inclusion. This needs to be recognized and put in proper perspective by policymakers and the regulator. Regional Appeal and Employment Creation The banking sector has many limitations. One, it is unable to service large segments of the population. Two, it is unable to design and sell a region-specific product. All banking products are uniform and lack regional flavour, while NBFCs are able to cater to a varied palate by customizing different products for different regions. Small-ticket personal loans, two/three-wheeler financing, loan against shares, public issue financing, financing for tyres and fuel are examples of this. NBFCs also help create employment in rural and semi-urban areas. Studies show that every vehicle sold provides direct and indirect employment to 13 persons, and hence, asset financing companies (AFCs) promote employment opportunities to many in the rural and semi-urban areas by providing finance for commercial vehicles.

10.4 Examining the Regulatory Regime for NBFCs Having recognized the role played by NBFCs in meeting the credit requirements of many unbanked and under-banked customers, and in creating employment for rural and semi-urban population, how do we nurture a happy coexistence of banks and NBFCs in meeting the infrastructure funding requirements and promoting growth?

130

10 Conclusions and Recommendations

Here is where supervisory and regulatory mechanisms become crucial, as do proper risk management systems. We identify the following challenges in chalking out a proper regulatory framework for NBFCs: A. Taxation Issues In his speech during the Union Budget for fiscal 2016, Finance Minister Arun Jaitley stated that the NBFCs registered with the RBI having asset size of Rs. 5 billion and above may be considered for notification as ‘financial institution’ in terms of the SARFAESI Act, 2002. It is not clear whether this provision will allow NBFCs with asset size of Rs. 5 billion and above to have all the benefits enjoyed by financial institutions as mentioned below. More clarification is needed on the following points: a. Treatment of NPAs under Section 36(1) (vii) (a) of the Income Tax Act, 1961 Banks are allowed to deduct up to 7.5% from the gross total income and 10% of aggregate average rural advances towards the provisions for bad and doubtful debts. Alternatively, they enjoy an option to claim a deduction of up to 10% in respect of any provision made for assets classified by the RBI as doubtful or loss assets. NBFCs, on the other hand, are allowed to deduct only up to 5% of the total gross income against NPA provisioning, although they are also regulated by the RBI and subjected to norms regarding income size, provisioning and CRAR. Hence, we recommend that NBFCs be allowed to avail of the above-mentioned provisioning on a par with banks. This would also be in line with harmonization. Furthermore, NBFCs are required to contribute 20% of the net profit to a special reserve, without any upper limit. If we look at the balance sheet of some NBFCs, the money under the special reserves is quite substantial. As of now, it is not clear what this reserve will be put to use for. The regulator may specify the limits of such contribution and prescribe the purposes for which it could be used. b. Income Deferral under Section 43D of the Income Tax Act, 1961 Banks, financial institutions and housing finance companies enjoy the benefit of the principle of taxing income on sticky advances only in the year they are received, under Section 43D of the Income Tax Act. As prescribed by the RBI, the NBFCs also follow the prudential norms so as to defer income in respect of their non-performing accounts. But they are not allowed to do so at present and they are taxed such deferred income on accrual basis, resulting in levying of tax on income which is/may not be realized at all. In order to create a level playing field and give a boost to net income, which is not artificial, NBFCs may be allowed to enjoy the benefit under this Act on a par with banks and housing finance companies. c. TDS on Interest Rate Payments under Section 194A of the Income Tax Act, 1961 This section requires tax deduction at source (TDS) at 10% on the interest portion of the instalments paid to the NBFCs under loan/finance portfolio. The exemption is

10.4 Examining the Regulatory Regime for NBFCs

131

up to Rs. 25,000 for banks, Life Insurance Corporation of India, Unit Trust of India, etc., whereas for NBFCs, it is only Rs. 10,000. In addition, this facility is available only for corporate and not retail deposits in the case of NBFCs. There is a case for extending the same exemption benefit to NBFCs’ retail business segment considering most of their retail customers come from unorganized and unbanked centres. Besides, NBFCs also cover SMEs in their loan portfolio. This will help them focus on financial inclusion. d. Prescribing Threshold Limit for TDS Asset finance companies of NBFCs raise funds through issue of NCDs to retail investors, and many of whom are from small households. In the case of non-listed debentures, TDS is to be deducted from the interest amount paid without any threshold limit. This practice poses a hurdle for small investors and, on many occasions, could limit the capacity of NBFCs to raise money. Hence, a threshold limit may be prescribed for TDS under the NCD route. Accordingly, it is suggested that Clause (v) of the proviso to Section 193 may be suitably amended. In order to enhance tax governance, NBFCs may be asked to furnish the PAN of retail investors and the interest amount paid to them. e. Depreciation for Construction Equipment Construction equipment used in many infrastructure projects does not enjoy 100% depreciation benefit under the Income Tax Act, while it is permitted in the case of equipment under pollution control, solid waste control, mines and quarries, energysaving devices, etc. In order to promote higher infrastructure investment, allowing 100% depreciation benefit for construction equipment would be an encouraging step. B. Review of Recommendations of the RBI Working Group Report, 2011 The RBI-appointed Working Group on Issues and Concerns in the NBFC Sector (RBI-WG) under the chairmanship of Usha Thorat released its report on 29 August 2011. In the table below, we review some of the key recommendations of this report, as these have strong implications for the future working and contribution of NBFCs. It is important to note that while some of the recommendations have already been implemented by the RBI (by circular dated 14 November 2014), some issues remain. To present the complete picture, all relevant recommendations are mentioned here. For long, it has been argued that most of the NBFCs are taking undue benefits owing to regulatory arbitrage and this has given rise to serious concerns for the RBI regarding ensuring and nurturing financial stability of the system. We understand and appreciate the concerns of the RBI regarding risk associated with a large number of unregistered/unregulated smaller entities, as their activities have a lot of interactions with low-income population, and if something goes wrong, this has huge political implications. At the same time, the RBI has amply appreciated the positive role played by NBFCs. In the last few years, world over, concerns have been expressed regarding the functioning of ‘shadow banking’ and regulators are taking steps to rein in their negative impacts. But in India, we do not have the kind of shadow banks as discussed

132

10 Conclusions and Recommendations

in the international arena (Sinha 2013). It is important that while strengthening the regulatory environment for NBFCs, wherever required, this should not lead to a situation which will kill their activities and thereby their contributions in the enhancing economic growth of India. The RBI has already positioned CRAR, income recognition norms, ALM, etc. The moot question is how to move forward while creating a level playing field and at the same time identify the risk at the incipient stage. More importantly, one has to recognize the role played by NBFCs in financial inclusion and this is very important for India at this stage. With this objective in mind, we address some of the recommendations of the Working Group Report and their implications for NBFCs.

RBI-WG’s recommendation/RBI action

Study’s comment/suggestion

1. NBFC-ND-SIs with assets more than Rs. 1 billion and NBFC-D with deposits more than Rs. 200 million have been asked to adhere to the norms of ALM as prescribed by the RBI Such NBFCs have to maintain a gap not exceeding 15% of their net cash outflows in the 1-month bucket

This would increase the cost of funds and pose a challenge when funds are drying up and push up the cost of funds for borrowers Earlier the NBFCs had to maintain this amount in a 1-year time bucket. While we understand the liquidity concerns of risk management for NBFCs, this could be easily addressed by prescribing a particular level of liquidity coverage ratio. The RBI may even consider relaxing this 1-month time bucket in stages. This would also bring NBFCs of the above category on a par with banks

2. NBFCs normally invest in money market instruments indirectly through liquid money market mutual funds. Hence, for the purpose of computing total financial assets, investment in liquid funds of mutual fund should also be included in the eligible liquid instruments 3. The RBI has increased the CRAR for NBFCs-ND-SI from 12 to 15% and to meet this higher capital requirement, and they were allowed to raise money through the issue of perpetual bonds. Recently, the RBI has increased the CRAR for deposit-taking NBFCs also

If we analyse the health parameters of NBFCs-ND-SI and NBFCs-D, the latter is one notch above the former. Hence, in order to create a level playing field, NBFCs-D may also be permitted to meet this higher capital requirement through the issue of perpetual bonds

4. The RBI-WG has suggested that Tier 1 CRAR be raised to 12% from the current one of 10% for all NBFCs. The main argument to support this increase is that the banks have to adhere to CRR, SLR and priority sector obligations

Many NBFCs-D and NBFCs-ND-SI are in a better position than banks. Moreover, banks have the risk weights for their borrowers. Based on the risk weight, capital charge varies In order to bring a level playing field, either the CRAR may be kept at the old level or the RBI may prescribe two or three categories of CRAR, each depending on a set of health parameters, where the best one will enjoy lower CRAR and the value of CRAR increases with the decline in the health parameters. The ultimate solution lies in moving towards ‘economic capital’, and in this context, prescribing risk-weighted CRAR requirements based on credit rating of the borrowers is very important. In this context, the credit rating obtained from the rating agencies could be a good starting point (continued)

10.4 Examining the Regulatory Regime for NBFCs

133

(continued) RBI-WG’s recommendation/RBI action

Study’s comment/suggestion

5. Since 1 April 2011, the RBI has prescribed that the total CRAR be increased from 12 to 15%, of which Tier 1 CRAR would be 10%. The RBI-WG has recommended that this Tier 1 CRAR be increased to 12%

Both the policy recommendations have deleterious effect on the cost of capital and would positively increase the lending rates for the borrowers. We totally agree that risk management principles must be given due recognition, and any kind of systemic risk must be addressed comprehensively at the incipient stage itself. The RBI has prescribed a calibrated risk-weighted regime for the banks. It is very important to consider the applicability of the same in the case of NBFCs If we go by the liability-side classification of NBFCs, the risk weights for asset financing/SME business/financial inclusion/priority sector lending may be reduced to 50%, and for all others, risk weights may be at 100%. This would force NBFCs to adopt risk-based culture in their business analytics, improving their risk-based performance

6. The period for classifying loans as NPAs in case of NBFCs is 180/360 days. The RBI-WG has suggested reducing this period

There is a clear incompatibility in this suggestion. While major health parameters are different for various segments of financial institutions, bringing them on a par in terms of period for classifying NPAs does sound well. For any financial institution, specific features of the borrowers, collection method, etc., needs to be considered while fixing the period for classifying NPAs. It must be recognized that many small borrowers have turned their business models to match the collection requirements. Hence, bringing down this requirement will significantly affect small business units

7. The NBFCs borrow money in general as working capital loans, and this money is used for onward lending. Currently, rated AFCs are allowed to accept deposits up to four times their NOF. The working group has suggested to reduce it to 2.5 times

As per the current regulation, all rated NBFCs are allowed to accept up to 1.5 times of their NOF. The rationale of this recommendation is not well founded. It also suggested that (i) the AFCs presently exceeding this limit are not permitted to take fresh deposits till such time as they reach limit, and (ii) rating of AFCs is needed. In general, AFCs borrow money through NCD, which is rated. Notwithstanding this, the suggestion regarding rating of AFCs is a good one. But the RBI may examine a graduated approach, where AFCs beyond a particular level of NOF shall have to go for rating, and below this threshold limit, they can raise funds only by NCD which shall be rated. Moreover, all unrated companies had to repay their entire outstanding deposits on or before 31 March 2018. The RBI may consider extending this time limit, as this would put heavy burden on their working and hence could reduce the profitability

C. Towards a Durable System of Providing Refinance Facilities to NBFCs (i) NBFCs are playing an increasingly bigger role in enhancing economic development. As estimated earlier, the credit from NBFCs as a percentage of unmet credit from the banking sector is increasing. It is important to examine whether there is a permanent source of finance for this sector, which would no doubt help increase its contribution to financial inclusion.

134

10 Conclusions and Recommendations

In the 1970s–1980s, when the economy needed investment in the housing sector, the RBI financed the NHB fully from its profits. Similarly, it ploughed back profits to promote agriculture and industry through the National Agricultural Credit (longterm operation) Fund, and National Industrial Credit (long-term operation) Fund. However, the RBI created the RIDF, when the credit flow to the priority sector fell short of the targeted amounts. Similarly, in promoting exports and export finance, the RBI created Exim Bank. Hence, the developmental role played by the RBI in providing credit to the needy sectors has paid many dividends. It goes to the RBI’s credit and to its vision that there exist diverse financial institutions in India meeting various types/tenures of credit. On similar lines, it is time the RBI thinks of creating a facility to provide finance for select NBFCs in augmenting their capacity to lend to unbanked regions and people who cannot access the banking sector, and where credit needs are region-specific—a gap that nationalized banks have been unable to fill. The RBI may designate an institution responsible to disburse credit to and monitor financial inclusion of the targeted population. Given the present institutional mechanism in India, the Small Industries Development Bank of India is one candidate that could be considered. As the GOI has established the MUDRA Bank, this too could be entrusted with this responsibility. As MUDRA Bank has potential from the financial inclusion point of view too, it would be an ideal organization to be entrusted with this responsibility. (ii) The contribution of NBFCs in providing credit to the production sector is well-recognized. In addition to the direct production credit, they also lend money to allied sectors, in terms of transport finance, infrastructure finance, etc. The RBI may consider easing of securitization of assets of these sectors, lower capital requirements and lower provisioning norms, on a par with similarly placed financial institutions. (iii) The share of owned funds as a part of total funds of NBFCs has gone up from 23% in 2005 to 26% in 2011. In this period, the use of public funds has declined significantly. But the contribution of NBFCs to provide credit to the priority sectors has risen, and to meet these credit requirements, NBFCs have borrowed from banks. As alluded to earlier, in order to nurture the coexistence of banks and NBFCs, it is important to consider such NBFCs on a special footing. They are different from those who lend predominantly to real estate or capital market transactions. (iv) In the past few years, bank lending to priority sector has not improved, and in fact, the money invested under RIDF has increased significantly. It is important to note that RIDF was created in order to make good the deficit under banks’ priority sector credit. It is also known that instead of lending to priority sector and facing challenges, banks find it very convenient to put the deficit in RIDF. In fact, the noise we make for financial inclusion emerges from the failure of the banking system in lending money to the agriculture/priority sector. In this sphere, NBFCs have done well and we must recognize this. In order to nurture their role in priority sector lending, the RBI may create a special window where banks could lend to NBFCs, which in turn, lend money to the priority sectors. In order to encourage this and bring greater transparency, external auditors could certify the money lent to the priority sector by NBFCs. Heavy penalties could be prescribed for those misusing the facility.

10.4 Examining the Regulatory Regime for NBFCs

135

D. Other Suggestions/Recommendations The RBI-WG suggested that all registered NBFCs need to get prior approval of the RBI when there is a change in control or transfer of shareholding of the NBFCs, directly or indirectly, exceeding 25% of their paid-up capital. a. Public Funds According to the Working Group, the ‘public funds’ refer to funds raised directly or indirectly through public deposits, CPs, debentures, intercorporate deposits, guarantees and bank finances or any other debt instrument. But this definition explicitly excludes funds raised by issue of share capital and instruments which have the feature of compulsory convertible into equity share. From the viewpoint of better prudence, as available in other jurisdictions, ‘public funds’ should exclude loans, deposits from the holding/group company, if funded through its internal accruals. The RBI may demand a certificate from the statutory/external auditor to this effect, as checking/verifying every case would involve manpower and time. b. Priority Sector Lending by NBFCs Banks have treated their lending to NBFCs that were on-lent to the priority sector, as priority sector lending. However, the RBI, through a circular dated 3 May 2011, disallowed bank lending to NBFCs to be classified as priority lending. Given the important role played by NBFCs in financial inclusion, it is suggested that the RBI resumes classifying such credit given by banks to NBFCs as priority sector lending. In order to ensure a proper surveillance mechanism, the RBI may ask external auditors of NBFCs and related banks to submit a clear statement establishing the end use of the funds. This will also enhance the monitoring mechanism at the bank level. c. ECB Financing In the past 4–5 years, the RBI has taken a number of steps in liberalizing foreign investment by Indian residents and ECBs. In continuation of these efforts, RBI may permit a select group of NBFCs to avail of ECBs. It is important to note that infrastructure finance companies are already allowed this ECB route. If this is approved in principle for other NBFCs, RBI may prescribe a limit on ECB for NBFCs till enough experience is gained. This step will no doubt reduce the cost of funds for NBFCs and their dependence on domestic funds. Those NBFCs which are permitted to avail of this facility would have to follow some strict rules such as (i) the end use of funds should be for onward lending to priority sectors; (ii) such NBFCs should have adequate reserves to absorb the exchange rate fluctuation; and (iii) they must demonstrate to the RBI that they have the necessary financial strength in a stressed scenario. The RBI may even consider creating exchange fluctuation reserve for such NBFCs at a later point in time.

136

10 Conclusions and Recommendations

10.5 An Update Recently, the RBI’s ‘Report on Trend and Progress of Banking in India 2017–18’ is published and also the ‘Financial Stability Report December 2018’ is also out. These two documents provide a reasonable update on the performance of NBFCs during 2017–18 and also the period covering up to September 2018. This update assumes more importance in the aftermath of ILFS crisis, where a number of negative criticisms were placed on NBFCs in the media. These media reports cast a number of doubts on the performance of NBFCs. As on September 2018, there were 108 deposit-taking NBFCs and 10, 082 nondeposit-taking NBFCs, of which 276 were NBFCs systematically important nondeposit-taking NBFCs and 9806 other NBFCs-ND, were available in India. NBFCsND-SI accounts for 8.8% of total assets of NBFCs. In this group, government-owned NBFCs hold more than 33% total assets which clearly bring out their importance. Due to various regulatory measures undertaken by the RBI, government-owed NBFCs, both deposit taking and non-deposit taking, were aligned with those of others. Nongovernment-owned NBFCs account for 89.5% of total assets of NBFCs-D category. This category of NBFCs accounted for 15.2% of total assets and 17.6% total credit as at the end of March 2018. Significant credit growth was cited as principal factor for the expansion of the balance sheets of NBFCs as NBFCs-D grew by 24.4% and that of NBFCs-ND-SI by 13.4% during 2017–18. While the retail and services sector are the driving forces, credit given to medium and large industries is witnessed a significant increase. On the sources of the funds side, debentures and bank borrowings were the principal factors. Banks found lending to creditworthy NBFCs is very safe in the aftermath of increasing NPAs in their portfolio. From the profitability viewpoint, due to increase in fund-based income, profitability has increased for NBFCs in 2017–19. Cost-toincome ratio decreased indicating enhanced operational efficiency. While the return on assets increased from 1.6 to 1.7% in 2017–18, return on equity increased from 6.9 to 7.5% during this period. Cost-to-income ratio decreased to 3.5 from 3.7%. Both gross and net NPAs declined during 2017–18. However, the proportion of substandard assets increased for the quarter ending September 2018. Capital to riskweighted asset ratio improved. All the above parameters were much comfortable compared to the respective ratio of the Scheduled Commercial Banks and much above the threshold limits prescribed by the RBI. On the basis of the above, it is clear that the recent ILFS crisis did not have significant impact on the NBFCs and there is no doubt a few NBFCs could be affected by this episode. There is no place for complacency. In the days to come, the NBFCs need to strengthen their health parameters. This alone will help them to continue their contribution in augmenting credit to deprived sectors and also in the financial inclusion arena.

10.6 Summing Up

137

10.6 Summing Up We have made a number of recommendations in the report based on the replies we received from the NBFCs, interactions with the Executive Council members who are in research houses, taking cues from brainstorming other working group reports with the NBFCs, etc. We have tried to maintain a balanced approach throughout the report, so that we amply recognize the trade-off between good governance, risks posed/faced by NBFCs, positioning of various risk management principles, management information systems, undue regulatory mechanisms not based on facts and figures, the contagion which could trigger financial instability, the role played by NBFCs in financial inclusion, etc. We are well aware that, finally, it is the RBI’s call to accept the recommendations. After all, one cannot ignore the proactive and positive role played by the RBI in promoting this sector. If we have a reasonably robust NBFC sector today in India, compared with the ‘shadow banking’ structure in other jurisdictions that posed threats to financial stability, the credit goes squarely to the RBI. Having said that, there are two important issues that need a serious debate. One pertains to the classification of NBFCs and the other to the supervisory and regulatory mechanism for this sector. There is significant confusion in the minds of public regarding NBFCs. Recently, when a chit company failed, much of the public including the press raised their voice against the RBI. Today, the public is not in a position to distinguish between a chit company, a nidhi, and a proper NBFC. This needs to be addressed adequately. The RBI must take steps to educate the public through the regional media, which has a deeper reach than the national one. On classification of NBFCs, there is significant confusion. Even though the NBFC Act clearly defines what can be classified as NBFC, the mushrooming growth of various types of NBFCs adds to a blur. The classification based on deposit-taking capacity is well-recognized now, and hence, this could continue. However, activity-based classification needs a rethink. Currently, there are seven categories—asset finance company, investment company, loan company, infrastructure finance company, core investment company, infrastructure debt fund and micro-finance institution. The RBI-WG suggested that loan companies and investment companies be merged into a single category. But NBFCs in these two segments have argued that their risk profiles are totally different and, hence, cannot become one category. While the assets of investment companies carry the risk of equity/capital markets, the asset side of loan companies largely comprise loans receivable. Hence, it is opined that the latter carry lower risks than the former. This needs to be examined further. The November 2014 circular of the RBI regarding the regulation of NBFCs has brought some degree of harmonization. Hence, it is suggested that if we go by deposittaking activity, we may have just three categories, viz. NBFCs-D, NBFCs-ND-SI and NBFCs-ND-others. Yet another classification goes by the liability. Then, we may have four groups —asset finance company, investment company, loan company and infrastructure finance companies. There were some arguments for creating NBFCs-loan company-

138

10 Conclusions and Recommendations

priority sector, as NBFCs lend a significant amount to the priority sector. In our view, this is not required, because the breakup of total financing into priority and non-priority could be brought into the reporting system, and creating a separate group would add to confusion. Second, we recommend throughout the report that NBFCs be given benefits in order to create a level playing field with banks wherever the logic supports it. We are not suggesting this benefit to be provided to all NBFCs indiscriminately. Such benefits may be granted to those NBFCs whose assets are Rs. 5 billion or more, so that they are robust, have a vibrant reporting system, and any risk could be identified at the incipient stage. The RBI may consider a graded set of benefits based on asset size or a set of health parameters such as CRAR, NPA ratio, expense ratio, yield on investment, strength of the balance sheet. Such a system of graded benefit would be a good incentive for NBFCs to adopt best risk management principles, as envisaged for the banking sector by the Bank for International Settlements. Finally, there is the moot question—should all NBFCs be supervised by the RBI? The past 4–5 years have witnessed a mushrooming of NBFCs, with very few registering with the RBI. The RBI also has limitations in terms of capacity and manpower. Moreover, many small-sized NBFCs do not have contagion risk, and the regulatory cost of supervising them outweighs the benefit. Hence, the RBI, in consultation with the Ministry of Finance, can work out a minimum threshold limit of AUM for supervision. Any NBFC falling below this could be supervised by a separate designated agency. If required, the RBI may prescribe a reporting format in which these NBFCs may submit data at the stipulated frequency.

References

Akhan, J. A. (2010). Non-banking financial companies in India: Functioning and reforms. New Delhi: New Century Publications. Asha, S. (2014). Asset liability management in Indian commercial banks. International Journal of Applied Financial Management Perspectives, 3(1), 858–862. Assocham and PwC. (2015). Banking on non-banking finance companies, January 2015. Available in PWC website: www.pwc.in. Assocham and PwC. (2016). Non-banking finance companies: The changing landscape. Available in https://www.pwc.in/assets/pdfs/publications/2016/non-banking-finance-companies-thechanging-landscape.pdf. Basu, K. (2010). Non banking financial companies. Oxford University Press: The Oxford Companion to Economics in India. Beck, T., Demirgüç-Kunt, A., & Levine, R. (2007a). Finance, inequality and the poor. Journal of Economic Growth, 12(1), 27–49. Beck, T., Demirguc-Kunt, A., & Peria, M. S. M. (2007b). Reaching out: Access to and use of banking services across countries. Journal of Financial Economics, 85(1), 234–266. Carbó, S., Gardener, E. P., & Molyneux, P. (2005). Financial exclusion. Basingstoke: Palgrave MacMillan. Carmichael, J., & Pomerleano, M. (1999). The development and regulation of non-bank financial institutions. The World Bank Publications. Claessens, S., Djankov, S., Fan, J., & Lang, L. (2002). Disentangling the incentive and entrenchment effects of large shareholdings. Journal of Finance, 57(6), 2741–2771. http:// ideas.repec.org/a/bla/jfinan/v57y2002i6p2741-2771.htm. Conroy, J. (2005). APEC and financial exclusion: Missed opportunities for collective action? Asia Pacific Development Journal, 12(1), 53–80. CRISIL. (2011). Report on retail NBFCs the shine is back, but will it last? CRISIL. (2014). Non-banking financial companies: CRISIL outlook on the NBFC sector, April 16, 2014. CRISIL Research. (2017). NBFCs: A special report by CRISIL research—2017 edition. https:// www.crisil.com/en/home/our-analysis/reports/2017/12/nbfcs-a-special-report-by-crisilresearch.html. Demirgüç-Kunt, A., & Klapper, L. F. (2012a). World development indicators database. World Bank. Demirgüç-Kunt, A., & Klapper, L. F. (2012b). Measuring financial inclusion: The global findex database. World Bank Policy Research Working Paper No. 6025.

© Springer Nature Singapore Pte Ltd. 2019 R. Kannan et al., Non-Banking Financial Companies Role in India's Development, India Studies in Business and Economics, https://doi.org/10.1007/978-981-13-3375-0

139

140

References

Dudley, W. C. (2009). Proceedings from the Centre for Economic Policy Studies (CEPS) Symposium 2009: More Lessons from the Crisis. Fabozzi, F. J., & Atsuo, K. (1991) Asset/liability management: Investment strategies, liquidity requirements and risk controls for banks and thrifts. Probus Publishing Company. FICCI. (2013). Role of NBFC's in promoting inclusive growth: Financial foresights views, reflection and erudition. Federation of Indian Chambers of Commerce and Industry, 3(5), Q4 FY 2012–13. FSB. (2011). Shadow banking: Scoping the issues—A background note of the financial stability board. http://www.financialstabilityboard.org/publications/r_110412a.pdf. FSB. (2012). Global shadow banking monitoring report 2012, November 2012. Financial Stability Board. http://www.financialstabilityboard.org/publication/r_121118c.pdf. FSB. (2014a). Global shadow banking monitoring report 2014, October 2014. Financial Stability Board. http://www.financialstabilityboard.org/publication/r_141030.pdf. FSB. (2014b). Report on shadow banking in Asia, regional consultative group for Asia, August 2014. http://www.financialstabilityboard.org/publication/r_140822c.pdf. FSB. (2015). Global shadow banking monitoring report 2015, November, 2015. http://www.fsb. org/2015/11/global-shadow-banking-monitoring-report-2015/. FSB. (2018). Global shadow banking monitoring report 2017, March 2018. http://www.fsb.org/ 2018/03/global-shadow-banking-monitoring-report-2017/. Gandhi, R. (2014). Re-designing regulatory framework for NBFCs. RBI Monthly Bulletin, 17–26. GOI. (1998a). The task force of the non-banking finance companies report submitted to Finance Minister Yashwant Sinha. Chair: C. M. Vasudev. GOI. (1998b). The report of the Committee on Banking Sector Reforms (Narasimham Committee-II), submitted to Finance Minister in April 1998. GOI. (2012). Report of the key advisory group on the non-banking finance companies (NBFCs). Ministry of Finance, January, 2012. GOI. (2014). Economic survey: 2013–14. Ministry of Finance. Gopinath, S. (2009). Addressing the regulatory perimeter issues—Indian experience. Herring, R., & Santomero, A. M. (1999). Financial regulation in the global economy. Washington, DC: Brookings Institution Press. Honohan, P. (2008). Cross-country variation in household access to financial services. Journal of Banking and Finance, 32(11), 2493–2500. India Ratings. (2013). 2013 Outlook: Major Indian non-bank finance companies. IFC. (2011). Intellecap analysis. World Bank Group: International Financial Corporation. IFC. (2012). A research study on needs, gaps and way forward. World Bank Group: International Financial Corporation. IMF. (2014). Shadow banking around the globe: How large, and how risky? In Global financial stability report: Risk taking, liquidity, and shadow banking: Curbing excess while promoting growth (Chap. 2). Karunagaran, A. (2011). Inter-connectedness of banks and NBFCs in India: Issues and policy implications. RBI Working Paper Series No. 21/2011. Levine, R., Loayza, N., & Beck, T. (1999). Intermediations and growth: Causality and causes. Washington, D C: World Bank Development Research Group. Leyshon, A., & Thrift, N. (1995). Geographies of financial exclusion: Financial abandonment in Britain and the United States. Transactions of the Institute of British Geographers, 312–341. Mohan, R. (2006). Economic growth, financial deepening and financial inclusion. Addressed at Annual Bankers' Conference 2006, Hyderabad, November 3, 2006. Pal, R., & Vaidya, R. R. (2011). Outreach of banking services across Indian States: 1981–2007 converging or diverging? In D. M. Nachane (Ed.), India development report 2011 (Chap. 12). Planning Commission Report on Sub-Group on Flow of Private Sector Investments for MSME Sector. Prakash, K. (2002). Financial inclusion in India: Some key statistics. DSP Merrill Lynch.

References

141

PwC. (2017). PwC’s non-banking financial company insights. https://www.pwc.in/assets/pdfs/ras/ financial-services/compliance-cco-advisory-services/non-banking-financial-company/pwcsnon-banking-financial-company-insights-analysis-of-regulatory-changes-and-impactassessment-january-april-2017.pdf. Raj Kumar, S. A. (2014). An overview of regulating frameworks of non-banking financial institutions. Available in www.caaa.in. Raj Kumar, S. A. (2018). Overview of provisions relating to non banking financial institutions (NBFC). Available at http://www.caaa.in/Image/45%20NBFC.pdf. Rangarajn, C. (2008). Report of the committee on financial inclusion (Chair: C. Rangarajan), January 2008. http://www.nabard.org/report_comfinancial.asp. RBI. (1992). Report of the working group on financial companies (Chair: A C Shah). RBI, Mumbai. RBI. (1995). Report of the expert group on designing a supervisory framework for non-banking finance companies (Chair: P. R. Khanna). RBI. (1998). Report of the working group on money supply (Chair: Y V Reddy). RBI. (1999). Harmonisation of the role and operations of DFIs and banks. Discussion paper of Reserve Bank of India. RBI. (2008a). Asset liability management for NBFCs. RBI. (2008b). Report of working group on rehabilitation of sick SMEs (Chair: K. C. Chakrabarty). https://www.sidbi.in/files/Working_Group_on_Rehabilitation_of_Sick_SMEs-Dr_KC_ Chakrabarty_committee_DM000PUB00087328509.pdf. RBI. (2011). Working group on the issues and concerns in the NBFC sector: Report and recommendations (Chair: Usha Thorat), August 2011. Reserve Bank of India. RBI. (2012). Handbook of statistics on Indian economy, 2011–12. RBI. (2014a). Monthly Bulletin, January 2014. RBI. (2014b). Committee on comprehensive financial services for small businesses and low income households. Chair: Nachiket Mor. RBI. (2017a). Reserve Bank of India Annual Report 2016–17. https://rbidocs.rbi.org.in/rdocs/ AnnualReport/PDFs/RBIAR201617_FE1DA2F97D61249B1B21C4EA66250841F.PDF. RBI. (2017b). Financial stability report, December 2017. RBI. (2017c). Report on trend and progress on banking in India. RBI. (2018). Database on Indian Economy, RB’s Data Warehouse. https://dbie.rbi.org.in/DBIE/ dbie.rbi?site=publications. Shah, A. C. (1996). Finance companies: Problems and prospects. Economic and Political Weekly, 31(12) (March 23). Shanmugam, K. R. (2015). An inter-country analysis on growth of non-bank financial intermediaries. MSE Working paper No. 100. http://www.mse.ac.in/wp-content/uploads/ 2016/09/Working-Paper-100.pdf. Shrestha, M. B. (2007). Role of non-bank financial intermediation: Challenges for central banks in SEACEN countries. The South East Asian Central Banks (SEACEN). http://www.seacen.org. Sinha, A. (2013). Regulation of shadow banking: Issues and challenges. RBI Bulletin, March 2013. The Economist Intelligence Unit. (2016). Global microscope: The enabling environment for financial inclusion. Thomson, B. J. (2009). On systemically important financial institutions and progressive systemic mitigation. Policy Discussion Paper 27, Federal Reserve Bank of Cleveland, August 2009. Tracxn. (2015). Alternative lending landscape: India, July 2015. Udit, M. (2010). Financial inclusion models from around the world. Forbes India Magazine, 19 November 2010. Vaidyanathan, R. (1999). Asset-liability management: Issues and trends in the Indian context. ASCI Journal of Management, 29(1), 39–48. Vijaya, B. (2014). Non-banking finance companies: Game changers. Speech delivered on January 23, 2014 at New Delhi.

142

References

World Bank. (2000). Nigeria financial sector review. Non Bank financial Institutions and Markets (Vol. 3). Washington, DC. https://openknowledge.worldbank.org/handle/10986/ 15101. License: CC BY 3.0 Unported. World Bank. (2003). Non-bank financial institutions and capital markets in Turkey. Washington, DC: World Bank Country Study. World Bank. (2017). The global findex database.