Mumbai: In May, Piramal Enterprises Ltd signalled its intent to carve out its financial services business into a separate entity. With the planned addition of a stressed assets platform to its interests in real estate financing and consumer lending, group chairman Ajay Piramal thought it was time to demerge the business, which expanded revenue 20% to Rs.9,299 crore in the year ended March.
For one thing, a demerger would help attract investors to financial services, given its high growth potential, said Piramal, whose businesses include life sciences, healthcare, specialty glass packaging and real estate, apart from financial services.
“If India has to grow, the financial services industry needs to necessarily grow,” Piramal said in a 7 June phone interview. “Given the growth projections (for the economy), financial services will grow anywhere between 15% and 18% in nominal terms.”
If it follows the script, Piramal’s financial services business will emerge as a conglomerate within a conglomerate, joining offshoots of large business houses such as Bajaj Finserv Ltd, Aditya Birla Financial Services, Reliance Capital Ltd and L&T Finance Holdings Ltd. These non-banking financial companies (NBFCs) are no longer one-trick ponies, but diversified and complex entities.
“Financial services conglomerates are getting quite common these days,” said Sanjeev Krishan, partner-transaction advisory services, PricewaterhouseCoopers.
Krishan explains that by bringing different business lines under the same roof, financial companies can benefit from synergies in distribution and customer acquisition.
“Two other points are relevant. Some of these firms had sought banking licences but were not successful. The second is the pace of (change in) regulations and technology, both of which are being disruptive and would change the way financial services businesses operate” said Krishnan.
The way Piramal sees it, there are three reasons to be optimistic about the non-banking financial services business at this stage.
First, state-owned banks, burdened by Rs.5.8 trillion of bad assets as of the end of March, will be “preoccupied” and may not have adequate capital to feed India’s economic growth. This leaves space for private banks and NBFCs to expand their reach. Second, large parts of the economy are not being serviced by banks, which NBFCs can capture. And third, there are some businesses, such as financing of land purchases, that banks are simply not allowed to do.
“That’s why you have seen growth in NBFCs and I see that continuing,” said Piramal.
Bajaj Finserv’s latest investor presentation pitches the company as “a non-bank with strategy, structure and support model of a bank”. It’s not far from the truth.
Bajaj Finserv, demerged from the Bajaj group in 2008, offers 18 different products through its NBFC Bajaj Finance alone. In addition, the group runs life insurance, general insurance and home finance subsidiaries. Bajaj Finance also takes deposits, although not on the same scale as banks do.
The rapid diversification and expansion of the company’s NBFC business has come in less than a decade.
In 2008, when Bajaj Finserv branched out from the group, its NBFC business essentially had three lines of lending: two-wheeler and three-wheeler loans, which constituted 75% of the book, and consumer electronics and personal loans.
Bajaj Finance’s total loan book stood at Rs.2,190 crore in 2007-08. In the fiscal year to March, it had grown to Rs.44,229 crore.
Managing director Sanjiv Bajaj says two key factors pushed the unit towards diversification. During the downturn of 2004-05, the company realized that unlike banks or other diversified business models, Bajaj Finance didn’t have the option of switching its focus to a business less vulnerable to a slowdown.
“…part of the learning was that being a monoline can take you through very significant stress in the downcycle. That was one of our inputs for building a diversified lending opportunity,” Bajaj said in a phone conversation on 10 June.
The company also felt that it needed to build a “stickier” relationship with its customers by offering a suite of products rather than a one-time loan.
“What we also realized is that if we are able to do that successfully, then it helped us boost our RoE (return on equity) because you are avoiding acquisition cost of the second, third and fourth product,” said Bajaj.
The company initially stuck to consumer lending products, but slowly expanded into the small and medium enterprise (SME) and mid-market lending segment.
Now that Bajaj Finance is virtually a bank, does it want to formally convert into a bank if it has the option to do so?
Not necessarily, says Bajaj.
“Five years ago, the answer would have been ‘Yes, that is the end goal’ because of the significant advantages that a bank had in India over NBFCs and other lending entities. Now, this is gradually changing partly because the arbitrage between NBFCs and banks is being reduced by RBI (Reserve Bank of India),” he explains.
“I think there is a huge opportunity in disintermediation that exists in India. I think when you become a bank, you get limited by RBI to lower your risk profile and what you can do. Hence, I think it’s a fairly open question going forward whether or not a good NBFC should be a bank or not.”
Ajay Srinivasan, chief executive officer of Aditya Birla Financial Services Group (ABFSG), is also not hung up on a banking licence even though the company had applied for one in the last round of licensing concluded in 2014. It didn’t get one.
Srinivasan says he thinks of his company as a non-banking financial conglomerate. Held under Aditya Birla Nuvo, ABFSG will eventually become a separately listed entity, although when and how remains unknown.
The listing will be validation of the growth seen by the financial services business of the Aditya Birla Group, which now extends across 12 business lines. Of these, the largest is the insurance business.
While each of the businesses is poised to grow, Srinivasan, like Bajaj, believes the NBFC business is at an interesting stage.
As economic growth picks up pace, the credit to gross domestic product (GDP) ratio, in other words, lending as a percentage of economic activity, is also expected to rise.
“With the rise of the non-performing loans of PSUs (public sector undertakings) banks and requirement of growth capital, some of that space will be taken up by these (NBFC) companies and there is reasonable headroom for everyone to grow,” Srinivasan said in an interview.
Given that opportunity, ABFSG’s focus in the next three-five years will be to expand its NBFC business.
Under-penetration will also allow the mutual fund and general insurance businesses to grow, Srinivasan reckons.
Over a 10-year horizon, newer business lines could emerge and allow non-banking financial firms to expand their reach quicker than banks.
Digitization of finance, in particular, could allow financial services companies to tap more customers without incurring significant costs.
For instance, ABFSG launched Aditya Birla MyUniverse (ABMU) in 2012. MyUniverse is an online transaction platform which helps in aggregating financial products, analysis and recommendations for individuals, while also executing transactions. The digital platform makes money through transaction fees and advertisements.
“This platform has helped us attract the younger population and leverage technology well,” said Srinivasan.
“It is essentially a one-stop shop that enables you to aggregate, advise and transact, all in one place. Today we are also the seventh largest SIP (systematic investment plan) distributor in India and that gives us an opportunity to scale up further with younger customers in our fold,” he added.
ABFSG, in a partnership with group firm Idea Cellular Ltd, is also launching a payments bank. That just adds to the bouquet of financial services that the group offers and the channels through which it offers them.
“As Aditya Birla Group gears up to go live with our payment bank shortly, the aim and ambition is to provide a wide spectrum of digitally empowered financial solutions at the fingertips of mass India,” said Srinivasan.
Along the way, there will be add-ons such the stressed asset segment that most financial firms are looking at. No decision has been taken to enter the segment, but the group is studying the opportunity.
At present, 60% of ABFSG’s revenue comes from credit-based businesses and the rest from fee-based services.
In the year to March, Aditya Birla Finance Ltd, the NBFC business, posted revenue of Rs.2,442 crore, a 37.5% increase from Rs.1,776 crore in the previous year. As of March, the NBFC had a book size of Rs.25,755 crore. Revenue rose 17.3% to Rs.9,299 crore in the year ended March.
“Ultimately, they are all becoming what I would call financial conglomerates. Except for a deposit-taking arm, they possibly have everything in their portfolio. Also, given that they have ownership control, they also are doing it more efficiently by setting up newer channels,” said Abizer Diwanji, leader of financial services at EY India.
“Even on the lending side, they are far more innovative with structured products or even consumer loans. They have built very good analytics and can go well below what the banking market serves, hence the yields are better. Increasingly, they will move towards structured wholesale lending and retail lending,” Diwanji added.
Some of India’s standalone NBFCs have already started to do this and most of them are betting on emerging opportunities in the wholesale lending segment.
At Edelweiss Group, the credit business contributes 75% of revenue, while the fee-based businesses bring in the rest, said Rashesh Shah, chairman and chief executive officer of the group, in a phone interview on 31 May.
The firm is expecting to maintain a similar business mix for the next five years after which it is seeking to lower the share of its credit business to two-thirds of overall revenue.
Edelweiss is also betting that eventually the bond markets in India will pick up and more financing will happen through the capital markets. This provides another opportunity for those in the debt capital market business. In preparation for that, Edelweiss recently hired Randhir Singh, who was formerly with Deutsche Bank AG’s India unit, as head of structured finance.
According to Shah, most financial services firms will need to run both credit- and fee-based businesses over time to diversify risk and ensure returns.
“Most of the diversified financial services firms will have credit as the foundation and base of the business and on top of that fee and commission income. There are almost 24-25 verticals in the credit space and a lot of NBFCs have a lot of room to grow in the present environment,” Shah added.
At present, nearly 80% of the lending market lies with the banks, 10-15% with the NBFCs and the rest with the bond market, said Shah. With banks sitting on a pile of bad loans and capital in short supply, there is an opportunity for NBFCs to swoop in and capture market share.
A testament to the potential in the non-bank financial services segment comes from the kind of deal activity this space has seen. In 2015, $1.17 billion in private equity money was invested in NBFCs, double the $540 million in 2014.
IIFL Ltd is one of the companies that has drawn marquee investors.
In July 2015, well-known global investor Prem Watsa increased his stake in the holding company, IIFL Holdings Ltd, by investing Rs.1,621 crore. In addition, IIFL Wealth Management Ltd raised Rs.1,122.34 crore by selling a 21.61% stake to global private equity fund General Atlantic Singapore Fund Pte. Ltd.
With money in the bag, R. Venkataraman, managing director and co-promoter of IIFL Group, says the company is betting on the NBFC and wealth management businesses to drive growth.
Over time, to improve its risk profile and reduce volatility of revenues, IIFL has cut its dependence on the broking business, which now contributes less than 10% of revenue.
“If you look at the landscape right now, I think NBFC provides significant opportunity simply because any economy which is growing needs capital or credit, and if you look at the banking structure, the PSU banks are not willing to give credit for various issues and that demand gets translated for NBFCs,” said Venkataraman.
At present, pure lending income makes up nearly 70% of the revenue for the firm, but Venkataraman believes that if the Indian economy has to grow, the capital markets will make a comeback. That will open doors for higher revenue from the capital markets and investment banking verticals.
IIFL doesn’t want to be left behind in the stressed asset segment either. It has recently applied to the banking regulator for an asset reconstruction company licence.
“With the ARC, we are waiting for the licence and then we will determine our plan on how to grow the business. On the NBFC part, our capital adequacy is roughly around 17% and we will definitely raise capital in the next 12 months on that side,” Venkataraman said.
According to the financial stability report released by RBI on Tuesday, NBFC loans expanded 16.6% in the year to March, twice as fast as the 8.8% credit growth across the banking sector on an aggregate level.