An Investigation into the Selected Non-banking Financial Companies in India

The non-banking financial companies (NBFCs) are important constituent components of India’s financial system. These are private sector institutions and have been there since the 1940s, although formally recognised by the Reserve Bank of India (RBI) only in 1964. This sector has grown substantially over the years, with the size of assets becoming almost 13% of India’s gross domestic product (GDP). These are regarded as shadow banking¹ entities and their activities largely fall outside the regular banking system (Financial Stability Board 2012). Being an emerging market economy, a considerably large section of the Indian society still remains out of the reach of the formal sector financial network. The NBFCs act both as substitute and complement for the banking system. Substitutability comes through its penetration into the geographical locations where formal banks are absent and complementarity through the process of financial intermediation with certain edge over banks, like lower transaction costs, proximity with the customers, and regulatory arbitrage to a certain extent. NBFCs cater to niche areas, such as automobile financing, gold loan, and agricultural credit. Success of the NBFC ecosystem is due to its diversified product lines with low costs, wider reach, lower bad debts, and better risk management. NBFCs in India fill the gap in extending financial services that still remain unfulfilled by the banking sector and corroborate the global trend in this regard. NBFCs are perceived to have quick decision-making ability, bring in flexibility as per the requirements of the customers, and assume greater risks and hence are free from the rigid structure of the banks.²

However, the overall vulnerable nature of the NBFCs in India remains a serious cause of concern. For instance, the so-called India’s mini-Lehmann moment is crucial here. The Infrastructure and Leasing Financial Services (IL&FS) went bankrupt, affecting the funding channels for other NBFCs in the market and created a scary situation for the banks as well (since banks, which are the major sources of funds for the NBFCs, hesitate to lend further to infuse liquidity). Although, a possible predicament in the NBFC market may have far-reaching implications on the formal sector banking. Unfortunately, this segment does not get any direct support from the central bank to tide away the crisis. Given this backdrop, we investigate the liquidity management issues and some other related aspects of the NBFCs in India. We are specifically interested since the overall functioning of the NBFCs remains largely unexplored despite the fact that the NBFC segment plays a significant role in India’s financial system. Thus, even when the literature on Indian banking is voluminous, that on NBFCs is astonishingly scanty. We study three specific issues: (i) the main parameters to be considered for examining financial performance of the NBFCs; (ii) performance of our sample NBFCs in terms of these parameters and their implications on the NBFC sector at large; and (iii) whether there is a need to tighten the regulatory standards for this sector?