ICRA explains: How NBFCs will gain from banking licences

A banking licence will help a non-banking finance company (NBFC) generate higher fee-based income, believes Vibha Batra of ICRA. Batra, in an interview to CNBC-TV18, says that NBFCs will manage this by offering a wider bouquet of services to its clients.

Batra believes that priority sector targets and current account/saving account (CASA) build up will be key to the success of these NBFCs. "If CASA is built up gradually and NBFCs are given some relaxation in priority sector targets, the transition would be more stable and sustainable for them. However, if such an allowance is not given, then possibly their return on equity (ROEs) would dip to single-digit in two years of transition before they pick up."

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The government has allowed private players and NBFCs to apply for a banking licence provided they meet RBI's criteria. The RBI, in February, also released  final guidelines on 'new bank licences' that would allow corporate entities to start banking operations.

Below is the edited transcript of Batra’s interview to CNBC-TV18.

Q: First if you could take us through this analysis about that you have done, the various scenarios that you have analysed and what are your takeaways have been?

A: We know that when a non banking finance company (NBFC) is going to convert into a bank, it would have certain advantages. The advantage would be primarily in the form of low cost deposit which is current and saving account. It will also have the ability to offer wider bouquet of services to its client, so the ability to generate fee base income would be higher. On liability side, it offers tremendous opportunity to approach more stable deposit base.

At the same time, there could be a negative carry because the priority sector targets are rather large. If one breaches those targets, the penalties are quite stiff. The Rural Infrastructure Development Fund (RIDF) investments, that typically a bank has to make if one is breaching the priority sector target, earns only 4-5 percent rate of interest.

There is credit provisioning which could increase because non-performing assets (NPA) recognition of NBFCs versus banks and also provisioning requirement on restructured advances is significantly higher for banks. There are so many parameters, so we try to do scenario analysis on each of these parameters and how each of this would shape profitability.

Our analysis indicates that in short-term possibly, the provisioning requirement would have a significant impact. However, what is going to impact the sustainability of profit is the priority sector targets and current account/saving account (CASA) build up. So, if CASA is built up gradually, because it will not happen overtime, and NBFCs are given some relaxation in priority sector targets, the transition would be more stable and sustainable for them. However, if such an allowance is not given, then possibly their ROEs would dip to single digit in two years of transition before they pick up so that was the output of various analysis that we did.

Q: Have you managed to do any sort of company analysis in terms of which company such as Mahindra and Mahindra Financial, Bajaj Finance any particular company that would possibly have the easiest transition from an NBFC to a bank?

A: We don’t comment on individual companies, but basically if we were to look at the business profile some of the NBFCs, they have a very large book which is eligible for priority sector lending. So, for those NBFCs, transition maybe smoother and NBFCs which do not have such a large priority sector book would see a larger hit.