Five reasons why Indian billionaires are hurrying to buy NBFCs amid a pandemic

SII CEO Adar Poonawalla (File Image: Twitter)

After Piramal Group’s acquisition of crisis-ridden non-banking finance company (NBFC) Dewan Housing Finance Corporation (DHFL) early this year, billionaire businessman Adar Poonawalla has become the latest industrialist to jump on to the NBFC bandwagon.

Rising Sun Holdings, a company controlled in his personal capacity by Serum Institute of India CEO Adar Poonawalla, announced a transaction on February 10 to acquire a controlling stake in Magma Fincorp (MFL), a non-banking financial company (NBFC). The deal will be carried out via a preferential issue of Magma Fincorp's equity shares worth Rs 3,456 crore. The deal also includes an open offer as per SEBI norms.

The Piramal group emerged as a winning bidder for DHFL after a prolonged bidding war. The NCLT is yet to notify the winner.

So, what is drawing big investors to the NBFC business?

To begin with, what are NBFCs? A simple definition is that NBFCs are financial intermediaries that are positioned between full-scale commercial banks and a category of borrowers who typically don’t get funding from banks, for instance small-scale real estate developers and businesses. NBFCs also process the loans very quickly compared to banks. This draws borrowers to non-banks even if they have to pay a higher rate of interest.

But, the RBI has always viewed NBFCs with a bit of extra caution since these entities have high interconnectedness with the mainstream banking system. At the end of September, banks have a loan outstanding of Rs 8 lakh crore to NBFCs, which has gone up from Rs 5.4 lakh crore in 2018. Mutual Funds, too, have exposure to the papers issued by NBFCs, although this has come down in recent years.

The NBFC segment has faced a roller-coaster ride in the past, post the collapse of IL&FS in 2018 and the subsequent mess at DHFL. Banks shut the door on most NBFCs, especially the smaller ones. It took more than a year for the risk aversion to subside. This (the liquidity crisis) has changed the risk perception on these firms, thus leaving banks worried about their existing exposure to the sector.

Even before the 2018 crisis, the RBI has had bitter experience with smaller lending institutions in 2010 when the Andhra Pradesh microfinance crisis broke out. This led to the creation of NBFC-MFIs later in December, 2011. This was the last major reform in the NBFC-segment.

Coming back to the original question, what is drawing Indian billionaires to shadow banking business now?

There are a few factors at play here:

One:  As mentioned above, NBFCs, more commonly known as shadow banks, were a lucrative business that every industrialist wanted a share in till 2018 when the IL&FS collapse happened. NBFCs used to consistently grow at 15-20 percent. Since then, the scenario changed and NBFC sector felt the heat of liquidity crunch. But, after two years, NBFCs are back in business and normalcy has come back to the sector. Liquidity constraints have eased. This is a good time for long-term investors to look at fresh business possibilities using an existing well-known brand.

Two:  The pandemic has impacted all businesses and company valuations. This may be the right time to look at potential businesses at a cheaper valuation rather than buying the same businesses at a higher value once things normalize. “This is the right time for an investor to enter the NBFC space,” said Raman Agarwal, Chair-NBFCs at Centre for International Economic Understanding. “The way NBFC sector has grown over years, it is bound to attract investors from all segments when valuations are cheaper,” said Agarwal.

Three: Shadow banks across the world are lightly regulated compared with regular commercial banks. To an extent, that was the case in India too. But Indian NBFCs are now entering a phase of tighter regulation that gives more confidence to the investors. Recently, the Reserve Bank of India (RBI) proposed scale-based regulations for NBFCs grouping them in multiple layers depending on their size and interconnectedness. Going by this, NBFCs in the lower layer will be known as NBFC-Base Layer (NBFC-BL). NBFCs in the middle layer will be known as NBFC-Middle Layer (NBFC-ML). An NBFC in the Upper Layer will be known as NBFC-Upper Layer (NBFC-UL) and will invite a new regulatory superstructure. Stringent regulation means more stability for the sector from an investor point of view.

Four: The RBI is largely in favor of converting big NBFCs to banks. An RBI working group had recently recommended that big NBFCs should be allowed to convert to commercial banks. Getting a bank licence from scratch is more difficult than acquiring an existing NBFC and converting it to a bank at an opportune time, according to Agarwal. “This (acquiring an existing NBFC) could be a stepping stone to becoming a bank. Instead of straight away going for a bank licence, the investor can buy an NBFC and then try for conversion to banks,” he said.

Five: Even if bank conversion doesn’t happen, running a retail-focused NBFC will be a profitable business proposition at this stage considering that banks do not have the reach in many areas where NBFCs actively operate. NBFCs typically enjoy a bigger margin than banks from borrowers. India is a largely underbanked country and NBFCs play a significant role in extending credit to far-flung areas of the country. A cash-rich group like the Piramals or Poonawallas has the opportunity to build a business tapping the under-banked borrower segments.