Second life3 min read . Updated: 20 Jul 2007, 12:24 AM IST
Unlike cats, finance companies are not believed to have nine lives. But these companies do have the proven ability to resurrect themselves every now and then. Ever since they first emerged in the mid-1980s as leasing companies, finance companies have stumbled through successive periods of crisis and renewal—and survived till now. What about the future?
Just a few years after they were once again written off as potential fossils, non-banking finance companies (or NBFCs, the preferred term in India) seem to have once again risen from the dead. This newspaper reported in its Thursday edition that many brokerages are busy setting up NBFC subsidiaries and channelling their margin finance business to them.
They are not alone. Over the past few months, for instance, many foreign banks alike have either set up their own finance companies or bought large stakes in existing ones. And a handful of microfinance institutions—that serve those at the bottom of the pyramid— have also converted themselves into NBFCs, in a bid to gain access to private equity and the capital markets.
A lot of these corporate moves have been driven by regulatory arbitrage—the desire to escape the clutches of some regulator or the other. Take the brokerages. Their regulator—the Securities and Exchange Board of India (Sebi)—has strict norms on how much money a brokerage can lend to its clients to buy shares. Brokerages cannot lend more than 50% of the value of the securities bought by their clients and that, too, only for a pool of 500 securities identified by Sebi. In contrast, an NBFC (which is regulated by the Reserve Bank of India—RBI) has a more open field to operate in.
The foreign banks are taking advantage of another sort of regulatory arbitrage when moving into the NBFC space. RBI has a fairly strict branch licensing policy and acquisitions of Indian banks are only a theoretical possibility right now. So, foreign banks trying to beat glacial growth at home cannot expand fast enough in a market that is doubling every three years. Given the fact that it will perhaps take years for these foreign banks to reach into every nook and cranny of the country through traditional banking channels, many of them have been keen on controlling finance companies that have no restrictions on branch expansion.
There have been calls to end such opportunities for regulatory arbitrage, and rightly so. The structure of any industry should depend on factors such as technology and the cost of capital, rather than on the imperfections in the regulatory landscape. There is hence a clear case for ironing out regulatory creases, so that we get a more rational industry structure in finance. There are already reports, for instance, that RBI is trying to convince the government to tighten FDI norms for NBFCs.
But there is more to the NBFC resurgence than just a few nifty leaps across regulatory hurdles. The core NBFC model is still a robust one. The best of them often have a very good understanding of the needs of clients whom banks are uncomfortable with—private traders, truck owners, speculators, small business men, etc. These are risky clients, and the trick to lend to them successfully is by managing risks very well.
The big-box banks can boast of computerized risk management models; but NBFCs have intimate personal knowledge of clients who would be called subprime in the US. And that is a clear competitive advantage.
The question is often asked whether banks will eventually wipe out NBFCs, especially after the Indian banking market is opened up in 2009. Our view is that NBFCs will survive and thrive—and not just as vehicles to escape regulatory chains.
Their business model has its own strong points. Coexistence is a strong possibility.
Do finance companies have a future in India? Write to us at email@example.com