NBFCs’ credit woes

Non-banking finance companies (NBFCs) are increasingly disseminating credit and financial services to underserved/unserved segments of the economy. Taking an overview of the sector, there are 9,325 NBFCs and 94 HFCs (housing finance companies). Nine NBFCs and 5 HFCs form the upper layer, while 89 HFCs and 404 NBFCs fall under the middle layer. The remaining 8,912 NBFCs are in the base layer. Their combined loan book is nearly ₹60 trillion, forming 33 per cent of the banking system’s loan book.

During the previous year, the credit growth of NBFCs was 27 per cent, far beyond bank credit. Experts have opined that the quality of credit could be maintained well if credit growth is around the nominal GDP growth that currently works out to 11.5-12 per cent. The NBFC sector is way ahead of the ideal benchmark, elevating credit risk.

Banks and NBFCs are two distinct types of lenders. Woes of credit risk management stem from the type of borrowers they handle which usually remain outside the lens of commercial banks. They have low digital and financial literacy. The sub-prime borrowers of banks could be prime borrowers of NBFCs.

Cost of operations

To be in business, NBFCs adopt flexible and differentiated credit risk management practices compared to commercial banks. Simplified business processes, possible gaps in documentation for quick processing of loans, flexibility in terms of credit, and ease of doing business to attract new borrowers could build incipient weaknesses in credit risk management. Despite the enhanced use of technology in the sanction and disbursement of loans, post-disbursement loan recovery is human-intensive. It increases the cost of operations and credit costs.

The Fair Practices Code (FPC) for all NBFCs mandates general principles on adequate disclosures of the terms and conditions of a loan to borrowers and that they should adopt a non-coercive recovery method. The follow-up for recovery of loans, many times is known to be tough and harsh on borrowers breaching norms set under FPC. In the process, NBFCs tend to build a business model loaded with excessive risk appetite.

In its monetary policy review (October 9), RBI expressed concern that an imprudent “growth at any cost” approach could be counterproductive. Accordingly, as a follow-up of its concern, RBI barred Navi Finserv, DMI Finance, Arohan Financial Services, and Asirvad Microfinance from sanctioning and disbursing loans for charging exorbitant interest rates to borrowers. RBI observed that these companies’ pricing policies, in terms of their weighted average lending rate (WALR) and the interest spread charged over their cost of funds, are found to be excessive and not in adherence with the regulations. RBI observed a 14 per cent spread on loans that prompted action.

NBFCs should learn from the recent RBI actions to improve their credit risk management systems and create new benchmarks in their internal operations to bring orderliness. It calls for a quick restructuring of the business model, risk management framework, governance and compliance orientation. A flamboyant attitude in pushing aggressive credit growth could increase the proportionality of sub-prime mix adding credit risk.

The tendency to grow at any cost and aim at extortionist yield on loans could be self-defeating in the long run and can invite credit risks of a magnitude difficult to manage. The slippage in asset quality could be devastating in the long run. The leadership has to be sensitive towards risks, compliance, and sustainability of business operations to build systemic robustness in credit operations.

Apart from the NBFCs called out, other NBFCs and aggressive kind of banks should take cognisance of regulation and build rigour, better checks and controls, and standard operating procedures meant for credit risk management to address woes.

The writer is an Adjunct Professor, at the Institute of Insurance and Risk Management, Hyderabad. Views are personal