The proposed mega merger between Housing Development Finance Corp and HDFC Bank has triggered talk of consolidation within the non-banking financial company (NBFC) sector. Industry experts are of the view that in order to sustain on a long-term basis, non-banks, especially small and mid-sized ones, will look at the amalgamation route.
This is because the regulatory arbitrage that was available to NBFCs is nearly absent now after the Reserve Bank of India (RBI) tightened regulations on non-banks. With this, large NBFCs face regulations almost on a par with that of banks.
“RBI has brought about measures such as increased capital requirements for NBFCs, harmonised NPA (non-performing asset) norms with banks, and liquidity coverage ratio being introduced for NBFCs, among other actions,” Y.S. Chakravarti, MD and CEO at Shriram City Union Finance told Moneycontrol. ”In addition, size matters in the financial services space, and larger players expect to benefit from economies of scale and lower borrowing costs. I believe these have been the primary drivers for NBFC consolidation,” Chakravarti said.
Further, high cost of funds, increasing competition, asset quality pressures, competition to attract high-rated borrowers at low rates and lower spreads could be some reasons for consolidation, Chakravarti said.
This is not the first time that consolidation in the NBFC sector has been talked about. Lower-rated NBFCs have struggled accessing liquidity at cheaper rates since 2018 when the beleaguered Infrastructure Leasing & Financial Services (IL&FS) defaulted on debt repayment, triggering a slew of liquidity problems for the sector. The introduction of the goods and service tax, demonetisation and the pandemic only exacerbated such lenders’ liquidity woes, analysts said.
The IL&FS event proved that NBFCs are an integral part of India's financial system and the RBI, thus, has increased supervision of such entities. The central bank has grouped NBFCs into different categories based on their size and interconnectedness and has made capital norms stricter.
The bigger ones are grouped in the upper layer with tight supervision while stringent regulations will apply to the middle layer as well. The top layer is reserved for companies that are perceived to carry elevated risks akin to banks under the prompt corrective action (PCA) framework.
The regulator on November 12 also came out with a clarification on upgrading of assets that resulted in a rise in reported gross NPAs of most non-banks in Q3FY22.
The RBI’s regulatory actions raise the accountability bar for NBFCs, and also cut them less slack than they used to have.
“The harmonisation of some of the key regulatory requirements of NBFCs with that of banks has reduced the leeway which was available to NBFCs in the past. This along with other factors including improved synergies, product or geographical diversification, better shareholder value, access to liquidity or lower cost of funds are the key reasons for the large merger proposals which are in news over the recent past,” said A.M. Kartik, vice-president and sector head of financial sector ratings at ICRA.
Kartik says that in the case of small and mid-sized NBFCs, it is more about the viability, future growth plans and access to funding that is resulting in mergers with relatively larger NBFCs. Access to funding for NBFCs is going to be a key differentiator going forward, he said, as the sector is highly reliant on the banking sector at present.
Bank’s exposure to the NBFC sector is quite high and near their internal sectoral limits, Kartik added. Incremental funding to NBFCs would be partly dependent on the banking sector’s own growth rate going forward.
“One could expect consolidation or M&A activity more amongst the mid-sized NBFCs with other similar-sized ones or larger entities, including banks, for achieving higher growth and/or for product /geographical diversification,” he said.
Jinay Gala, associate director at India Ratings & Research, says the merger of HDFC and HDFC Bank will likely be used as a test case for all upcoming large-ticket mergers in the NBFC sector.
While there is a possibility of small NBFCs merging with bigger ones to gain scale and associated benefits, NBFCs may also look at acquiring fintechs to upgrade and scale their existing technology infrastructure.“We foresee that there could be an increase in consolidation in the non-bank sector to avail benefits of a larger franchise, larger product basket and a larger reach so that they could remain competitive to other lenders like banks and small finance banks,” Gala said.