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3.1 Global Scenario of Industry

The role of the NBFC is defined as the financial intermediary and the particular task has been

well recognized by the finance sector as well as the customers. The key drivers of this sector are

the quick decision making abilities, risk management and the intricate understanding of the

customer needs. The way the NBFC players have managed to spread their operations in urban as

well as semi-urban areas in the span of a few years, is simply commendable. Today, the role of

NBFC has become important from the macro as well as the Indian economic point of view.

The NBFC sector is dominated by the construction, equipment and the commercial vehicle

market and the other assets included under this. This industry has been growing consistently at a

rate of 20-25% barring the negative fall in the year 2008, which was due to the global scenario.

However, the industry has revived very quickly and has crossed volumes of more than that of

2007. The expected growth of return from this sector in the near future looks to be about 30-

35%.There is more than three and half lakh crore non-deposits taking place in the NBFC sector

and around 85,000 crore deposits taking place."

The most drastic change that has been seen recently in the NBFC segment is that of the big

international companies setting shop in the NBFC sector. Till sometime back, no big company

would have even thought about investing and trading in this sector.

Sustainable growth is possible only with the right dynamics which suit the market demand and

requirement. Many experts feel that the bad economic phase which shadowed the world, has

taught a few valuable lessons to the players in the NBFC sector. As in the case of any sector, the

recession made it apparent that it is difficult to maintain a consistent growth pattern if the growth

is not planned.

International players are trying to set foot in the Indian market, but I am not sure if they will get

the Indian environing right. We have had a similar situation where MNC's have tried their best to

set foot in the Indian NBFC market and place them in the urban sector. But, surprisingly, the

NBFC sector has now occupied the semi-urban and rural markets and the dynamics involved in

both the markets are very different.

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In the NBFC sector commercial and private vehicle market is going to grow but the tractor

market is going to be one of the fastest growing components, as it is no longer an agro project

but also an infrastructure investment.

NBFCs have traditionally been the secondary borrowing institutes and their main source of

borrowing has been the banks, mainly the public sector banks. This is the main reason why the

borrowing rate in the NBFC sector is a few percent higher than the public sector banks. In terms

of business establishment and rate on return (RoI), NBFC have a neat 2% RoI as compared to the

1.2 - 1.4% of a public sector bank.

1

1http://articles.economictimes.indiatimes.com/2010-12-22/news/27600737_1_nbfc-sector-nbfc- industry-finance-sector

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3.2 Characteristics of Global Industry

Global credit crisis followed by increase in interest rates in October and November 2008 resulted

in widespread crisis of confidence. Chain of events after the collapse of Lehman Brothers is still

fresh in the minds of investors. Non-Banking Finance Companies (NBFCs) in India were

severely impacted due to economic slowdown coupled with fall in demand for financing as

several businesses deferred their expansion plan. Stock prices of NBFCs’ crashed on the back of

rising non-performing assets and several companies closed their operations. International

NBFCs’ still continue to close down or sell their back end operations in India.

The positive news however is that, this crisis has forced NBFCs to improve their operations and

strategies. Industry experts opine that they are much more mature today than they were during

the last decade. Timely intervention of RBI helped reduce the negative effect of credit crunch on

banks and NBFCs. In fact, aggressive strategies helped LIC Housing Finance to grab new

customers (including customers of other banks) and increase its market share in national

mortgage market. Surprisingly it was able to maintain its profitability in 2009 (around 37%).

HDFC, the largest NBFC in India, however experienced a slowdown in customer growth due to

stiff competition, especially from LIC Housing Finance and tight monetary conditions.

Other NBFCs that were stable during this period of credit crunch are Infrastructure Development

Finance Company (IDFC) Power Finance Corporation (PFC) and Rural Electrification

Corporation (REC). Growth prospects are strong for these companies given the acute shortage of

power in the country and expected increase in demand for infrastructure projects.

The segment which was hit hardest was Vehicle Financing. Companies financing new vehicle

purchases experienced a drastic reduction in new customer numbers. Fortunately, since vehicle

finance is asset-based business, their asset quality did not suffer as against other consumer

financing businesses. Contrary to this, Shriram Transport Finance, the only NBFC which deals in

second-hand vehicle financing was able to maintain its growth primarily due to its business

model which does not entirely depends on health of the auto industry.

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3.3 PEST Analysis of Industry in world Market

The “radical and ongoing changes occurring in society create an uncertain environment and have

an impact on the function of the whole organization”. A PEST analysis is merely a framework

that categorizes environmental influences as political, economic, social and technological forces.

The analysis examines the impact of each of these factors (and their interplay with each other) on

the business. The results can then be used to take advantage of opportunities and to make

contingency plans for threats when preparing business and strategic plans.

PEST analysis is a useful strategic tool for understanding market growth or decline, business

position, potential and direction for operations. The use of PEST analysis can be seen effective

for business and strategic planning, marketing planning, business and product development and

research reports. PEST also ensures that company’s performance is aligned positively with the

powerful forces of change that are affecting business environment. PEST is useful when a

company decides to enter its business operations into new markets and new countries. The use

of PEST, in this case, helps to break free of unconscious assumptions, and help to effectively

adapt to the realities of the new environment. 1

[1] POLITICAL FACTORS

Political forces can have a great bearing on financial services. This influence could take the form

of a command-type economy, with a large proportion of financing occurring via government or

government-controlled institutions. This would include the overriding of market mechanisms by

state planning and bureaucracy. It could determine political structure.

Factors Influence

Quota Positive Influence

NBFCs Guidelines Positive Influence

Tax Benefits Positive Influence

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i. QUOTA

The Reserve Bank of India (RBI) has tabled reforms to the funding practices of NBFCs

(non-bank lenders) in a move that some observers believe underlines its determination to

limit the growth of a shadow-financial system.

The Reserve Bank of India on June 27, 2013 said it would introduce a "minimum set of

guidelines" for all private placements from financial companies, previously a popular

source of funding for the sector.

Financial companies rely heavily on the institutional market to fund their loans, since

most are not allowed to accept retail deposits. That means any action to restrict their

access to the debt markets could have a big impact on the sector's expansion.

The backlash to the proposed rule change triggered an unusual climb-down, and the RBI

withdrew the restriction on the frequency of private placements in a July 2, 2013 notice,

promising a revision "in due course".

Some local market participants, however, see the RBI's recent interest in this alternative

financial system as part of an on-going effort to clean up the country's financial sector

and prevent the growth of a less-regulated shadow banking system. That fits with recent

regulatory actions against financial companies such as financial companies.

ii. NBFCS GUIDELINES2

Profit - Because of the changes in the norms of NPAs the profit will be affected

adversely in the short run to non-banking financial companies. But complementing to this

fact is that the increase in the capital will be a positive factor as it will increase liquidity

and thus the profit.

Margin Funding – Because of the risk weightage going up and the disclosure of every

day transactions, it will be difficult for the NBFCs and hence margin lending will be

affected. 

ROA – As the days to recognize if an asset is an NPA or not is decreased, it will decrease

the ROA and also there will be loss of assets. The average return on ROAs will drop by

25 basis points and affected to non-banking financial companies.

2 http://www.fundasinfinance.com/1/post/2013/08/the-impact-of-new-nbfc-guidelines.htmlA Study on Non Banking Financial Companies in India

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Transparency and Valuation of NBFC– As the norm suggests more disclosure of the

transactions there will be transparency in the system and this will help in the proper

valuation of NBFCs. This will play a huge role in this sector as they will have to

strengthen its internal system of reporting.

Size of NBFC – The small NBFCs will be impacted severely as they rely on first time

borrowers and small NBFC will be tem moving out of this sector owing to the above

issues of profitability and margin funding.

Quality and Risks – The overall quality of NBFCs will improve as they will be little

more risk free owing to the increase in their capital which will provide liquidity in the

issues of mismatch.

Overall, the guidelines seem to converge further towards financial services regulation on

the important parameters of capital and liquidity. Real estate and capital markets attract

higher risk, weight and disclosures. However, this creates some significant issues for the

sector to deal with.

Two scenarios are possible: better regulation will create better opportunities and better

NBFCs will adapt as they have done in the past and deliver. On the other hand, many of

them may not find the business viable in the absence of the opportunity space between

financial companies and borrowers.

[2] ECONOMIC FACTORS

Factors Influence

Exchange rate Positive Influence

Inflation Negative Influence

GDP Positive Influence

Consumer Price Index Negative Influence

Foreign Direct Investment Positive Influence

i. EXCHANGE RATE3

3 http://www.exchangerates.org.uk/USD-INR-exchange-rate-history.htmlA Study on Non Banking Financial Companies in India

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Years Exchange rate Growth of NBFCs (%)2008-09 46.80 17

2009-10 45.03 19

2010-11 48.74 32

2011-12 54.86 20

2012-13 63.30 19

2008-09 2009-10 2010-11 2011-12 2012-1315

25

35

45

55

65

75

Exchange Rate NBFCs Growth Rate

The currency rate of India is ranging from 40 Rs per dollar to 50 Rs per dollar. The currency rate

will going to effect to the exporter as the government is helping to the NBFC industry but the

final money earned by exporter will depend on exchange rate. The overall impact of this

exchange rate will mix, as the rate of exchange will high then the exporter will earn high and

vice-versa. The overall impact of exchange rate in current scenario is favourable and affected to

non-banking financial companies.

ii. INFLATION

Average Inflation India (CPI) - by year4

4 http://www.inflation.eu/inflation-rates/india/historic-inflation/cpi-inflation-india.aspxA Study on Non Banking Financial Companies in India

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Average Inflation Inflation Growth of NBFCs

CPI India 2013 11.04% 17%

CPI India 2012 9.30% 19%

CPI India 2011 8.87% 32%

CPI India 2010 12.11% 20%

CPI India 2009 10.83% 19%

2008-09 2009-10 2010-11 2011-12 2012-130.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

Inflation Growth of NBFCs

Indian banks’ lending to non-banking finance companies (NBFCs), perceived as a high-

risk sector, has virtually come to a halt due to the combined impact of regulatory

tightening by the Reserve Bank of India (RBI) and slowing business.

Growth in bank lending to NBFCs dropped to 1.9% in the 12 months ended June 2013

compared with 44% in the same period last year, according to RBI data. In absolute

terms, bank loan outstanding to NBFCs stood at Rs.2.58 trillion, marginally higher

than Rs.2.54 trillion in the year-ago period.

The decline in bank lending is more evident in the three months ended June, when banks

lent just Rs.20 crore to NBFCs, registering a growth of 0.8%, against a 11.4% growth in

the year-ago period.

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RBI first began choking bank funding to NBFCs in May 2011 by removing the so-called

priority sector tag for bank loans to NBFCs, except for those loans given to companies

operating in specific segments such as microfinance. This substantially raised the cost of

funds to NBFCs.

“Banks have been highly cautious due to the heightened concentration risks, as

suggested by the high growth, in the NBFC sector. Concentration risk to low-rated

NBFCs or weak NBFCs created concern,” said Prakash Agarwal, associate director,

banks, India Ratings, formerly known as Fitch Ratings India.

iii. GDP5

Years GDP Growth Rate6 Growth of NBFCs (%)

2008-09 7.5 17

2009-10 9.3 19

2010-11 7.7 32

2011-12 5.5 20

2012-13 4.7 19

5 http://economictimes.indiatimes.com/topic/NBFC6 http://www.tradingeconomics.com/india/gdp-growthA Study on Non Banking Financial Companies in India

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2008-09 2009-10 2010-11 2011-12 2012-130

5

10

15

20

25

30

35

GDP Growth Rate Growth of NBFCs

GDP is considered the broadest measure of a country's economy, and it represents the

total market value of all goods and services produced in a country during a given year.

Since the GDP figure itself is often considered a lagging indicator, most traders focus on

the two reports that are issued in the months before the final GDP figures: the advance

report and the preliminary report. Significant revisions between these reports can cause

considerable volatility. The GDP is somewhat analogous to the gross profit margin of a

publicly traded company in that they are both measures of internal growth.

According to Crisil feels RBI's new guidelines on lending against gold will weaken the

competitive positions, growth prospects, profitability, and asset quality of gold loan non-

banking financial companies (NBFCs). It expects the profitability of these NBFCs to

decline by nearly 75 basis points and their loan books to decline in the near term.

However, the new guidelines, issued on September 16, 2013, will promote orderly,

sustainable growth in the sector over the long term.

A FICCI survey on new bank licenses states: RBI's decision to allow new players in

the non-banking financial sector has received big thumbs up from Indian industry.

The move will induct new processes and technology, improve efficiency, enlarge the

capital base to meet the credit needs of the economy and generate huge employment

opportunities. The survey which drew responses from existing financial services, NBFCs,

A Study on Non Banking Financial Companies in India

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corporate and industrial houses and other stakeholders reveals that a majority (88%) of

the respondents feel that RBI condition for an applicant applying for a banking license to

set up at least 25% of its branches in unbanked rural centres with a population of less

than 9,999 will play a significant role in expansion of non-banking services to mid cities

and rural India and hence help in increasing financial inclusion in India. 

iv. Consumer Price Index

The CPI is a measure of the change in the prices of consumer goods across over 200

different categories and affected to NBFC. When compared to a nation's exports, can be

used to see if a country is making or losing money on its products and services. Be

careful, however, to monitor the exports - it is a focus that is popular with many traders

because the prices of exports often change relative to a currency's strength or weakness of

NBFC.

Some of the other major indicators include the purchasing managers index (PMI),

producer price index (PPI), durable goods report, employment cost index (ECI), and

housing starts affected to non-banking financial companies. All of these provide a

valuable resource to traders, if used properly.

v. FOREIGN DIRECT INVESTMENT

Foreign direct investment (FDI) in non-banking finance companies (NBFCs) has been

subject to minimum capitalisation norms. For example, any foreign investment of more

than 75% in an NBFC requires a minimum capitalisation of US$ 50 million through

foreign inward remittances.

As far as downstream investments are concerned, the Consolidated FDI Policy

Circular provides that the relevant caps and conditionality’s shall apply to downstream

investments as well. However, there is a specific exception for 100% foreign-owned

NBFCs where there is no restriction on establishing downstream subsidiaries without

further capitalising each subsidiary with the minimum required foreign investment.

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However, this specific dispensation was not available to NBFCs where foreign

investment is between 75% and 100%. By way of a Press Note No. 9 (2012) Series, the

Government has now brought such NBFCs on par with 100% foreign-owned NBFCs,

whereby they can also set up downstream subsidiaries without further capitalising each

one of them with the requirement minimum amount.

A report in the Business Standard sets out some of the advantages of this change:

The rule has made the business very capital intensive for companies that have FDI, as

most of them prefer a subsidiary structure to carry out different types of businesses.

This was not the only problem. Norms say that a NBFC has to set up separate arm for

different set of activity. It means a NBFC who is in the business of custodian service and

then it decides to go into leasing and finance, it needs to set up a different arm.

Previous regulation meant such a NBFC, if having more than 75 per cent FDI but less

than 100 per cent and a capital base of $50 million, it would need to bring another $50

million. Now this will not be required.

[3] SOCIAL FACTORS

Factors Influence

Literacy Positive-Negative Influence

Household Saving Positive Influence

LITERACY7

One of the major hindrances in the growth of the NBFC industry is the financial illiteracy of the

people. This makes it difficult in creating awareness of microfinance and even more difficult to

serve them as microfinance clients. Though most of the financial services claim to have

educational trainings and programmes for the benefit of the people, according to some of the

experts the first thing these SHG and JLG members are taught is to do their own signature. The

worst part is that many MFIs think that this is what financial literacy means. 7 http://www.iitk.ac.in/ime/MBA_IITK/avantgarde/?p=475A Study on Non Banking Financial Companies in India

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HOUSEHOLDS SAVING8

Households have been putting less money in financial savings recently. Two recent reports on

the macro economy have drawn attention to this development, which has deep implications for

the non-banking financial companies.

According to the Economic Outlook, gross financial savings (measured as increase in gross

financial assets), which was at 15.4 per cent of gross domestic product (GDP) in 2007-08, fell to

13.6 per cent in 2010-11, and could have possibly fallen to below 12 per cent in the next year

(2011-12). Even more relevantly, net financial savings of households available for use by the rest

of the economy fell below 11.6 per cent of GDP in 2007-08, to 10 per cent in 2010-11 and likely

to go below 9 per cent in 2011-12.

The RBI’s estimate is even less upbeat: household financial savings fell to 7.8 per cent (of GDP)

in 2011-12, the lowest since 1989-90. During the preceding three years, it averaged 11 per cent.

When the economy is faring well, households tend to put more money in non-banking financial

companies. In a buoyant economic environment, it is very likely that the stock markets will be

bullish and financial companies will also look attractive.

[4] TECHNOLOGICAL FACTORS9

Technology has both direct and indirect effects on the restructuring of non-banking financial

companies.

increases in the feasible scale of production of certain products and services (e.g. credit

Cards and asset management);

Scale advantages in the production of risk management instruments such as derivative

Contracts and other off-balance sheet guarantees.

8 http://www.thehindu.com/opinion/columns/C_R_L__Narasimhan/when-household-savings-

evaporate/article3878073.ece

9 http://www.fundasinfinance.com/1/post/2013/08/the-impact-of-new-nbfc-guidelines.htmlA Study on Non Banking Financial Companies in India

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Economies of scale in the provision of services such as custody, cash management, Back

office operations and research.

With the government’s help and the technology up gradation this sector has many growth

opportunities.

[5] LEGAL FACTORS

Factors Influence

Tax Benefits Positive Influence

iii. TAX BENEFITS10

The finance ministry is likely to extend the favorable tax treatment currently given to

financial services, public financial institutions and state finance corporations on their

income from non-performing assets (NPAs) to non-banking financial companies

(NBFCs) as well, making them taxable only in the year of receipt.

At present, NBFCs are taxed on such income in the year of accrual, while banks, PFIs,

state finance corporations, housing finance companies and state industrial investment

corporations are taxed only when it is received or credited to the profit and loss account,

whichever is earlier.

Department of financial services and the banking regulator have favored the extension of

the accounting benefit under Section 43D of the Income Tax Act to NBFCs too at pre-

budget consultations within the finance ministry. NBFCs are bank-like institutions with

the exception that these do not offer savings accounts.

Like other lenders, NBFCs too follow the Reserve Bank of India's (RBI's) prudential

norms and defer income regarding their NPAs and make provisions for the same.

However, income tax authorities do not recognize these norms and tax NBFCs on such

deferment of income on accrual basis resulting in tax on unrealized income.

Sources in the department of financial services said the government is "positively

inclined" to offer tax parity to NBFCs and the other lenders describing it a "reasonable

10 http://www.indianexpress.com/news/nbfcs-likely-to-get-tax-treatment-parity-with-banks/1077380/A Study on Non Banking Financial Companies in India

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demand" and hinted that the Budget could announce this change. The issue came up for

discussion during a meeting in Mumbai on February 9 between industry representatives

and officials including finance minister P Chidambaram, and senior officials from the

department of financial services and the RBI.

A Study on Non Banking Financial Companies in India