The Reserve Bank of India has put in a new regime for non-bank financial companies (NBFC), like more capital, stricter bad loan norms, independent directors for the larger NBFCs, more disclosures. But how are NBFCs expected to grow? Is the end game for a good NBFC, a bank licence and is a bank licence at this juncture all that attractive in the first place.
Former State Bank of India, head, AK Purwar and N Shivaraman, executive director, L&T Finance discuss about the new regime put up by the RBI from NBFC. AK Purwar, post retirement, is now an NBFC veteran.
Below is the edited transcript of his interview to CNBC-TV18.
Q: The new rules by Usha Thorat have put in many onerous capital conditions, the NPL recognition from the current 180 days to 90 days like any bank, whole host of disclosures, not just credit rating, the usual disclosures which banks have to make but also disclosure on credit rating, any penalties by any regulator at any point in time. If an NBFC is over Rs 1,000 crore they must also disclose provision coverage, liquidity ratio, extent of financing of parent company products, off-balance sheet exposures, structured products, that all lot of money. Will NBFCs become weaker or stronger after these rules?
Purwar: Let us see the context under which these rules have come. When you look at the global markets and financial markets, financial crisis in different parts of the world is affecting global growth and there is a need to strengthen the financial system. These recommendations need to be seen in that light; you need to increase your capital, have adequate capital for the purpose, and strictly classify your asset so that non performing assets (NPAs) are properly disclosed. I would say that this is a beginning and in due course a little stricter norm should be in place as far as capital adequacy is concerned.
Q: Will margins not be constrain immediately because you will provide more, even for standard assets you have to provide at 0.4 percent as well as be on the look out for more capital. When I look at Indian scenario, I find a genuine case of scaling up of NBFC not present. HDFC is one large NBFC. Shriram Transport is very good company but a niche player, where have they been able to diversify? Where they have been able to scale up and now if there these quality controls scaling up will be an issue?
Purwar: I don’t think so. If these quality controls are in place, scaling up will be far more qualitative in nature and there will be discipline in markets as it grows.
Q: Ultimately, banks are your source of finance. You may get equity capital from private shareholder sources or private equity but ultimately your daily bread comes from debentures which is very expensive source as well as bank finance which has controls like exposure norms, single group exposure. The fact that the Reserve Bank premise lending to NBFC is not really the safest of businesses, they almost classify sometimes very close to capital market exposure. In that context do you think scaling up is easy?
Shivaraman: On the funding source, the NBFCs have always dependent on multiple sources of funding. It is just not the bank lines. There are the banks, debenture institutional borrowing, mutual funds and the retail investors. Given that the banks have not really exhausted the full limit on NBFCs, I think bank loans do continue to be a good source available to us and we have not experienced any short fall, even though there are regulation changes which took place two years ago.
There is no inability to raise money from the banking segment. It is true that all of us need to diversify our funding source and need to look at the direct mobilization and using the banks as an intermediary for raising money from the retail investors. It is not necessarily expensive; it is expensive because it is done once a while but if it is done like deposit products on continuous, then distribution will be so difficult to do it. HDFC has grown well and they have both retail and institutional franchise, we should develop that.
Q: HDFC is turning out to be an exception; HDFC’s book is around Rs 1 lakh crore that will make it 15th-20th largest bank. Why don’t they scale up? Is funding not an issue?
Purwar: There is no funding issue for HDFC.
Q: Why are they not able to diversify? Why doesn’t any NBFC look like a small bank?
Purwar: NBFCs has been created to a particular segment of the market. Many of the NBFC have been created to cater to the niche market segment. They have specialized, they have grown. If you see the country’s economy, the service sector constitutes more than 50 percent of the county’s gross domestic products (GDP), and the products we have in that sector, leaves much to be desired. Therefore, NBFCs which are present in niche market can’t be compared; one cannot say that you have a diversified portfolio because they have been created for certain purpose.
Q; I am not compelling NBFCs to become diversified. I feel that Yes Bank or a Kotak can start 8-10 years ago and still look to scale up to Rs 1 lakh crore whereas an NBFC like HDFC that started 25 years ago is still only of a comparable size of a small bank and also there may be some niche NBFCs. Why are they none which look already like a small bank with adequate diversified activities?
Purwar: Don't look at HDFC on a standalone basis, it has be looked as HDFC group as a whole. I believe that they are highly diversified. HDFC has kept the NBFC focus on certain areas. As far as the general areas are concerned, they have created specialized outfits.
Q: So, for an NBFC to grow you need a banking license?
Purwar: I like to bet to differ on that, If NBFCs of a certain size fulfill certain prerequisite criteria then they should get a banking license. If you ask NBFC to scale up they should have banking license. I think some amount of examination needs to be done.
Q: Is banking license lucrative now? I think for NBFCs to really scale up there is a need for a banking license from the available evidence. Do you think that scaling up even with a license is going to get more difficult? Where are Kotak and Yes now? They have not really reached any scale even after eight years. Now, public sector banks are better savvier than they were in 2002 or 1994. Are more private sector banks for competition? So, do you think the new licensees will find it hard to scale up?
Shivaraman: We need to understand that in financial services business, especially lending, growth cannot be a goal, be all and end all in itself. Growth should be a result, that is what we plan and work for it. Growth should be a result of all correct actions to be competitive. Though, as you mentioned that some banks have not scaled up, but they have been growing at a compounded annual growth rate (CAGR) of 25-30 percent, which is a fair growth.
Even an NBFC, like most of them have grown in the region of about 25-40 percent over the last 5-7 years, which is good. If the NBFC grows at 25-40 percent then there is a no reason why we should not grow as a bank as well. At this rate, India provides fairly strong opportunities for financial services despite growth in financial services; it overall constitutes less than 10 percent of the overall GDP share.
I think the most mature market is in the excess of 20-25 percent. So, opportunity exits. I think it is welcome to have a quality competition, which is both efficient and return oriented.
Q: One of the more likely ways of growth would be inorganic because the new rule states that the promoter would be perhaps 20 percent or 26 percent. Final rules are still not out. But if it is 26 percent then it would make sense for someone who has got that license to start his bank and reverse merge with the existing smaller private sector banks because the scaling up is much faster. Do you think that is a route people will choose because now we are inviting even corporate houses?
Purwar: That is a possibility. But I don't think that route will be taken in a very big way. It may happen in a select way, maybe by way of an exception, not by way of general rule. In today's environment, some NBFCs have created a huge amount of successful track record in financing certain select areas. Some of the NBFCs have placed themselves with huge amount of branch network, which is larger than some of their smaller banks just on hope of getting license tomorrow or so. Then there would be certain organisations, which would be right for banking license and for them converting into a banking license and getting into banking business will comparatively be much easier.
Q: Do you think inorganic route will not be preferred considering that you may expect one or two corporate groups to get a license?
Shivaraman: For inorganic growth, one don't need to reinvent the wheel all over again in terms of both putting in place the system process as a branch network. Inorganic opportunity is definitely an interesting option. I don't want to say that it is attractive or not because it because it ultimately depends on, which bank you are looking at and what valuation it comes at? While looking at inorganic opportunity we need to be careful that the goals of the existing management under new shareholders are well-aligned in terms of growth and cost structures.
Everything should be aligned for it to be successful. Otherwise one could end up spending a lot of good amount of time for getting the alignment in place and we also need to look at from RBI's point of view. If their objective is to create new large banks, whether this inorganic opportunity will actually fulfill that requirement? I think it is doable because many of them have not been able to raise capital or they did not want to raise capital and have remained a regional or a small player.
So, a person, a large entity getting into it with a good capital commitment can really make them into a big bank. So, it can also in a way fulfill RBI's requirement. Now, with many of these NBFCs being located in the tier 3 and tier 6 locations and I don't think the branch licensing will play a role in that because we can convert all of them so long as they fulfill their minimum requirement to be a bank branch. So it is possible. So, it is required and not required you can say that rather it is a double-edged weapon.