The key proposition of non-banking financial companies (NBFCs) in the past has been their ability to deliver customised credit to borrowers in the retail space, who remained largely untapped by banks. Over the last two decades, they have been the first movers in many new asset segments - microfinance, small-ticket consumer finance, used vehicles finance, small business loans etc., thereby creating a unique franchise for themselves. The same resulted in the NBFCs having a strong focus on their identified target product line, which was developed keeping in view the specific borrower requirements in mind.
To their credit some of them built stronger business models, moulded their underwriting, improved operating efficiencies and competed hard with other new entrants, including banks, and at times were able to deliver much better performance than banks.
On the other hand, the banks historically have always had a well-diversified portfolio mix across sectors and products but largely relied on agriculture lending, mid and large corporate and infrastructure lending to meet their business growth aspirations. While banks are able to scale-up well in a few segments in the retail space, namely new vehicle finance, large and mid-size mortgages, high ticket personal loans, credit cards etc., they typically find it unviable to operationally gear up to cater to most of the other target retail borrower segments, which the NBFCs operate in.
Operational rigour, the hallmark of NBFCs
The NBFCs have painstakingly created a franchise, where in the absence of credit quality information, assessment involved significant operational rigour. They focused initially on asset-backed lending and have steadily diversified to other products, including unsecured loans as witnessed in the past few years.
Unlike the past, today, many NBFCs have up to four or five product offerings compared to only one or two key products, say a decade back. While specific NBFCs such as housing finance companies (HFCs), microfinance institutions (MFIs), etc. have relatively limited diversification options due to the regulatory requirement to focus on their principal businesses, many other NBFCs do not have such a requirement. Diversification becomes more apparent when a consolidated or group level data is assessed, instead of standalone data, as entities float new companies and/or acquire other entities to meet their diversification needs.
Competition leads to diversification
A prime reason for expanding their product profile has been growth, as competition, especially with banks, was becoming heated in their traditional asset segments, and for higher return expectations, as sector leverage had come down over the years.
The NBFCs cross-sold new loan products to their existing franchise, and also partnered with fintechs and/or smaller peers to venture into newer asset and borrower segments, especially for smaller ticket personal and digital loans targeting new-to-credit borrowers. They also entered into arrangements with banks for offering products, which targets a prime borrower than their traditional borrowers.
The rapid pace of digitalisation, and the continuously evolving opportunities in the retail lending space, coupled with new products, have changed the lending landscape and borrower expectations significantly.
Technological advancement and the digital stack is helping both banks and the NBFCs expand their product suite and reach more borrowers. The Unified Lending Interface (ULI), which is in its pilot phase, currently has linkages with various data sources that can facilitate further expansion in the borrower catchment and ease out overall credit delivery. While ULI has the potential to iron-out the overall credit underwriting and democratise borrower data, provided the borrower consents, the key for the lenders would be in ensuring healthy loan collections and active borrower engagement to assess early warning signals and evolve their risk management practices.
In-house collection team matters
The NBFCs have developed their own collection teams and clearly seem to have an added advantage on the asset quality parameters, compared to the rest. While many players who entered new products hoped that the underwriting rigor, improved credit bureau and other borrower lifestyle-related data availability would reduce the need for collection agents, the changing market and regulatory dynamic make it very important for entities to have in-house teams to manage a sizeable part of the business and not rely on a fully outsourced model.
An in-house collection infrastructure also is the key for the NBFCs looking to grow and diversify their product offerings by partnering with other players and originating loans for them.
Regulatory convergence on assets side possible
Possibly the continuously increasing interlinkages between banks and the NBFCs is one of the many considerations for the RBI to start harmonising regulations for both the factions. While we do not expect the harmonisation on the liability side in the near term, further alignment on the asset side, governance and risk management practices cannot be ruled out.
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