Role of NBFCs in the Indian Financial Sector

The financial institutions are usually classified as banking institutions and non-banking financial institutions (NBFCs). The banks subject to legal reserve requirements can advance credit by creating claims against themselves, while the non-banking financial institutions can lend only out of resources put at their disposal by the ultimate savers. The distinction between the two has been highlighted by savers while characterizing the former as “creators” of credit, and the letter as mere “purveyors” of credit.

NBFCs and Monetary Policy

The proliferation of NBFCs in India has coincided with a major structural transformation in the Indian financial system, which has an important bearing on the conduct of monetary policy.

  • NBFCs started functioning in the sphere of mobilization of dormant assets and tapping of new users of credit. In the process, they channelized savings in the economy by collecting funds from savings surplus units and allocating them to savings deficit units for investment in real assets, for consumption, for portfolio adjustment of existing wealth, or for all such purposes for which access to bank credit was either denied or restricted. This mechanism is called “transmutation effect” which refers to the catalytic role of financial intermediaries in converting financial liability with a set of characteristics into financial assets with a different set of characteristics, so as to tailor the asset preference of the economic agents.
  • Non-banks provide credit to those sectors which are denied credit by banking sector, thereby defecting to some extent the very purpose of quantitative credit controls. Further, it is often argued that financial innovations place an upward pressure on the money multiplier.
  • In a regime of monetary policy operating through monetary and credit aggregates as the intermediate target, the growth of NBFCs tend to dilute the efficacy of monetary policy. On the other hand, it is also true that in a regime of monetary policy transmitting through open market operations with interest rate as an intermediate target, the existence of financially strong NBFCs can increase the potency of monetary policy.
  • The NBFCs should be brought under the regulatory framework not only to ensure their healthy growth but also to improve the efficiency of the credit and monetary policy as well as healthy financial discipline among both providers and users of credit.

Innovative Financial Services Extended by NBFCs Sector

Initially intended to cater to the needs of the savers and investors, NBFC later on developed into institutions that can provide services similar to those of banks. In India, several factors have contributed to the growth of NBFCs. They provided tailor-made services to their clients. Comprehensive regulation of the banking system and absence or relatively lower degree of regulation over NBFCs has been one of the main reasons for the growth momentum of the latter. Further, their higher level of customer orientation in as much as lesser pre/post sanction requirements, simplicity and speed of their services have attracted customers to these companies. The monetary and credit policy followed by the country has left a section of the borrowers outside the purview of the commercial banks and NBFCs catered to the needs of this section. Further, the marginally higher rates of interest on deposits offered by the NBFCs have also attracted towards them a large number of small savers.

The activity of NBFCs can be fund based as well as fee based activities. For the former activities, the companies require funds. However, there is a limit on the deposits which the NBFCs can raise.

Fund Based Activities

Fee Based Activities

  1. Equipment leasing
  2. Hire purchase
  3. Bill discounting
  4. Loans/Investments
  5. Venture Capital
  6. Housing Finance
  7. Factoring and Forfeiting
  8. Equity participation
  9. Short term loans
  10. Inter corporate loans
  1. Issue management
  2. Portfolio management
  3. Corporate counseling
  4. Project counseling
  5. Loan syndication
  6. Arranging foreign collaboration
  7. Advising Acquisition and Mergers
  8. Helping in Placement services
  9. Advising on Capital Restructuring

 

Recent Trends in Non-Banking Financial Companies Sector

Initially intended to cater to the needs of the savers and investors, non-banking financial companies later on develop into institutions that can provide services similar to those of banks. In India, several factors have contributed to the growth of NBFCs. They provided tailor-made services to their clients. Comprehensive regulation of the banking system and absence or relatively lower degree of regulation over NBFCs has been one of the main reasons for the growth momentum of the latter. Further, their higher level of customer orientation inasmuch as lesser pre/post sanction requirements, simplicity and speed of their services have attracted customers to these companies. the monetary and credit policy followed by the country has left a section of the borrowers outside the purview of the commercial banks and NBFCs created to the needs of this section. Further, the marginally higher rates of interest on deposits offered by the NBFCs have also attracted towards them a large number of small savers.

After the CRB fiasco, the Reserve Bank of India had tightened its control over NBFCs. The unprecedented regulatory norms issued suddenly during January 1998 were perceived by NBFCs to be very harsh. While the RBI has maintained that such regulations were absolutely necessary to safeguard the public deposits, it has not spent adequate time for the development of NBFCs. In fact post CRB, negative sentiments, uncertainty about future of NBFCs among depositor have been resulted in the increased withdrawal of matured deposits and a serious slow down in the flow of fresh deposits. An attempt has been made in this article to review the various measures taken by RBI recently towards betterment of NBFCs. After a period of nearly 16 months since January 1998, the RBI has made certain relaxation for NBFCs. Firstly, it had removed the ceiling of bank credit in respect of all registered NBFCs. Secondly, it has classified bank credit to NBFCs for on-lending to small transport operators as priority sector lending. The move which has been perceived as a reversal of the Central Banks’ stringent stand is expected to have a two fold impact. Accordingly, it will come as a major relief to transport financiers which have been facing a service funds crunch following restrictions of mobilization of public deposits. The new classification is expected to prompt banks to extend more credit to this sector.

Services of NBFCs to Investors

A variety of services is offered by NBFCs. Majority of the services rendered by NBFCs are similar to those services rendered by merchant bankers. The services may be classified as corporate financial advice’s,  corporate structuring, issue management, corporate financing, foreign capital and foreign exchange advice/management, secondary market functions,  portfolio management services, consumer financing, financial market research and so on. Certain services are discussed below:

  • Forex management: Foreign capital/forex management services are the up-end function in great demand. Advice on floating GDRs, FCCBs and ADRs, foreign loan/financial syndication’s, forex risk management, foreign market opportunity evaluation, currency swap, etc are come under forex management.
  • Secondary market operations: In the secondary market almost all NBFCs, small and big, are active membership in one of more regular stock exchanges and in either of both of OTCEI and NSE are common with the large and medium operations. Some provide instant liquidity to sellers of scripts through them. For their operations in NSE, separate subsidiaries are established as per requirements of NSE.
  • Portfolio management services: Portfolio management services involve constructing, operating, improving auditing and revising portfolios on behalf of individual and institutional investors who put their funds with NBFCs for a certain period. Financing of portfolio is also done. Investment financing for applying for primary issues and for secondary market dealings is also provided by NBFCs.
  • Consumer financing: In the 1980’s NBFCs well as banks plunged into this field. Car financing, white goods financing, housing finance etc come under this category. Due to credit worthiness of customer is not fully known, the NBFCs provide financing through manufacturers of, or dealers in these goods. A tripartite credit system is thus evolved and generated.
  • Inter corporate deposits: Inter corporate deposits/loans are deposits by cash rich concerns with cash scarce concern. The deposits are generally for a period of 90 days and carry an interest of 7% to 8% per Annum depending on credit standing of the deposit seeking firms. As a single depositor may not be in a position to meet the needs of a borrower, syndication route is adopted and a plural number of deposit making firms are drafted together by NBFCs. Some times a collateral security may be instead.
  • Capital market research: Equity research, debt research, knowledge of market sentiments and forces, knowledge of fundamental of individuals. Scrips and the market knowledge of ‘technical’ aspects of market price movements, knowledge of the risk types and of managing the same etc are needed. Capital market research is the route to obtain the knowledge and skill needed. Dominant NBFCs have sophisticated research and databases.
  • Deposit mobilization: The NBFCs enormously depend on fixed deposits mobilized from investors for carry out their operations. A higher interest rate, more than bank deposit rates, is generally offered. The interest rates ranges between 8 and 11 percent per annum. Credit rating for fixed deposits was made mandatory by the RBI whereby unrated NBFCs having net-owned funds exceeding Rs. 2 crores are prohibited from accepting deposit. Fixed deposits for a minimum period of 12 months, and one day, for a maximum period of 84 months. RBI is interested in reducing the over-dependence of NBFCs on fixed deposits.

The NBFCs are playing a unique role in mobilizing funds, directing investment, providing a push to developement, especially in the industrial sector, catering to the varied financial needs of medium and rural sector. All in all, thriving, healthy and growing non-banking financial sector is necessary for promoting the growth of an efficient and competitive economy. Thus, NBFCs have emerged as a unique institution in the Indian financial system bridging the credit gaps in several sector.

About Abey Francis

Abey Francis is the founder of MBAKnol - A Blog about Management Theories and Practices - and he's always happy to share his passion for innovative management practices. You can found him on Google+ and Facebook. If you’d like to reach him, send him an email to: [email protected]

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