Alive and kicking: What common thread links the new-age NBFCs?

Using their imagination,new-age shadow banks have shown that their business model can fly

Nearly five years ago, a clutch of financial-industry veterans bet some Rs 6,000 crore on reinventing the shadow banking business. Their entrepreneurial ventures kicked off around the time that the blowouts at Infrastructure Leasing & Financial Services (IL&FS) and Dewan Housing Finance Corporation (DHFL) occurred.

While obituaries were being written of non-banking financial companies (NBFCs), Vimal Bhandari of ARKA Fincap, Gunit Chadha of APAC Financial Services, Gaurav Gupta of Adani Capital, Aseem Dhru of SBFC Finance, Bhupinder Singh of InCred, and Shachindra Nath of UGRO Capital — to name a few — have refashioned the sector.

Among them, Bhandari has batted on the NBFC turf all through his career. He was part of the team that drew up the business model for IDFC, an institution set up in 1997 to finance infrastructure, focusing primarily on project finance and mobilisation of capital for private-sector infrastructure development. What common thread links the new-age NBFCs?  “The approach is to be narrow and deep rather than being wide and shallow,” says Bhandari.

That is, they do not mimic banks by straddling business from corporate to retail with risky propositions, such as loans against property, or shares. All this even as the large majority of such entities remains dependent on lines of credit from banks. The way in now is to focus on a sector — say, small enterprises, and drill deep. Ticket-sizes may be small, at Rs 500,000-1 million, but it’s a volume game.

“In choosing the NBFC model, capital allocation is critically important. Building excellence in a focused line of business, or in a specific target market, can create significant value for customers and shareholders,” says Gunit Chadha, founder of APAC. He reckons that the problem starts when NBFCs diversify into areas where they have no competitive advantage, become conglomerate look-alikes, and try to be all things to all people. “They then start to become an inferior version of commercial banks, given their funding-cost disadvantage. That’s when regulatory costs grow as systemic risks increase and NBFCs clamour for bank licences.”

Even Adani Capital — the last to enter the game, and backed by a large conglomerate — has opted for the “small is beautiful” route. It grew its book to Rs 4,000 crore with a net profit of Rs 25 crore in Q2 FY23 (and projected to be Rs 100 crore in FY23), up smartly from Rs 1,200 crore and Rs 2 crore in FY20.

“The biggest change today is that businesses have clearly identified their target segment and what they are trying to solve. Our working capital solution is an instant end-to-end digital solution for the self-employed. We have also rolled out an ‘industry first’ instant re-finance for farmers,” says Gupta, managing director and chief executive officer of Adani Capital.

The moonwalkers

Even before the mess at IL&FS and DHFL, there were indicators that the shadow banking space was being looked at anew.

TPG Capital had led a $100-million funding drive for Five Star Business Finance just before IL&FS imploded. In July 2019, it raised another $50 million led by TPG, valuing the Chennai-based NBFC at $950 million. Backed by Matrix Partners, it raised money from Morgan Stanley, Sequoia Capital, and Norwest Venture Partners. And Chadha — founder of APAC (and the former Asia Pacific boss of Deutsche Bank) — got Multiples, the private equity (PE) firm headed by Renuka Ramnath, to pick up a 37 per cent stake in his firm, a month after IL&FS hit the headlines.

Five Star is now listed (it raised Rs 1,588.5 crore last November); and Dhru of SBFC Finance also plans to raise a similar amount. It hurts the HDFC Bank veteran when folk keep reminding him of the pitfalls of the shadow bank model. “When private banks came in, it was said they will decimate NBFCs; and later, that NBFCs existed because of regulatory arbitrage,” he gripes. Then adds with delight: “Now that RBI has silenced that argument, what would it take to see the writing on the wall? NBFCs exist because customers want us to fulfil needs left unmet.”

Part of the “NBFCs-are-finished” narrative may also have been fuelled by a misreading of RBI reports. Take the RBI’s Report on the Trend and Progress of Banking India 2018-19. It called attention to the fact that the number of NBFCs whose certificates of registration were cancelled quadrupled to 900 in FY19. (They could not meet a minimum net worth of a mere Rs 20 million.)

Now, one way to look at it is that it’s about the small fry who anyway did not want to be on RBI’s radar. Another is to view it as a subset of the thinking within RBI on NBFCs, and how the larger financial world looked at NBFCs — that their usefulness was all but over.

False narrative?

And that is why it was believed that there would never be a rerun of the boom period between FY15 and H1 FY18, when PEs had pumped in $2.36 billion into NBFCs. Indeed, even when Advent International injected Rs 1,000 crore into Birla Capital (with a like contribution by the promoters) in August 2019, not many were ready to buy into it as a lung-opener for capital-raising for NBFC as a genre.

And for good reason: Valuations of a few NBFCs were down by nearly 40 per cent in some cases. Ratings of NBFCs became critical — an “AA” grading was deemed good, and even “BBB minus” in some cases. But more importantly, it depended on the business models of NBFCs.

Says Nath, executive chairman and managing director at UGRO Capital: “I am from a small town, the son of school teachers, and had to sweat it out.” As Religare Enterprises’ chief executive officer in a past avatar, he had become famous as a whistleblower.

In 2018, he raised Rs 950 crore from ADV Partners, NewQuest Capital Partners, Indgrowth Capital, PAG (formerly the Pacific Alliance Group), and a few family offices — the biggest-ever fund-raise by a professional in the business to date. It boils down to reputation.

It appears that the NBFC sector has put its troubles behind it. More than 9,000 NBFCs are currently registered with the RBI, but the combined balance sheet is approximately one-fifth that of scheduled commercial banks. At the end of H1 FY23, aggregate credit extended by NBFCs grew by 13.1 per cent, to Rs 31.5 trillion.

A recent report by CareEdge Ratings notes that over the past four-and-a-half years, while NBFC loans to industry lost market share and fell to 37.5 per cent in H1 FY23 from 40.6 per cent in FY19, it was still the largest segment, followed by personal loans at 29.5 per cent, services at 14.7 per cent and agriculture at 1.7 per cent. Advances to service and retail segments grew the fastest in H1FY23.

The RBI Report on the Trend and Progress of Banking in India 2021-22 observed that the bottom lines of NBFCs improved in FY22 with the waning of Covid-19. With strong capital buffers, adequate provisions, and sufficient liquidity, NBFCs are poised for expansion. Nevertheless, going forward, NBFCs need to be wary of rising borrowing costs as financial conditions tighten. On the regulatory front, scale-based regulation is expected to strengthen NBFCs in step with the growing scope for organic consolidation in the sector.

The reality is that for all practical purposes (other than the fact that not all NBFCs can raise deposits), NBFCs are on a par with banks — even on governance. On April 29, 2022, the RBI issued guidelines for fixing the compensation for key managerial personnel (KMP) and senior management of NBFCs. They are now required to constitute a Nomination and Remuneration Committee (NRC), which will be responsible for framing, reviewing and implementing the compensation policy.

The NRC is also required to ensure the “fit and proper” status of both proposed and existing directors. It is also required to ensure that there is no conflict of interest in the appointment of directors on their boards, KMPs and senior management.

The chorus now will be: “We are back.”