Licence to bank

In early March, Reliance Capital surprised the market with an announcement that it was entering the microfinance segment—it said it would lend to microfinance institutions (MFIs) that would then advance money to self-help groups and poor people at the grassroots level. On the face of it, this initiative wasn’t novel, except that it came from a non-banking finance company (NBFC) in a segment that most banks are still reluctant to enter.

Then, 18 months ago, when over a dozen banks evinced interest in taking over the beleaguered United Western Bank (UWB), one bid attracted more attention than the others—it was from Indiabulls Financial Services (IBFSL). UWB finally went to IDBI Bank, but these two examples—about a year-anda-half apart—show the rising ambitions of NBFCs in the financial services space. “We do have banking ambitions, but our business model is independent of whether or not we get a banking licence,” says Gagan Banga, CEO, Indiabulls Financial Services.

These two aren’t isolated examples. NBFCs are aspiring to become one-stop shops for all financial services, and, in the process, coming into direct competition with scheduled commercial sector banks, especially in the private sector. “NBFCs are now looking at the financial services business in a much more holistic manner than before,” says Praveen Kadle, CEO of the newly set-up Tata Capital. Adds Atul Pande, Managing Director, Cholamandalam DBS Finance: “The difference between banks and NBFCs is narrowing and the scope of regulatory arbitrage is getting increasingly diluted.”

New verticals

NBFCs are now offering products like credit cards, housing loans, SME loans, demat services, online and offline broking services, and also distributing MF and insurance schemes—which were traditionally done only by banks. This is in marked contrast to the situation prevailing only a few years ago when they focussed mainly on merchant banking, hire purchase and leasing and small ticket consumer loans.

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Helping this growth is their business model. Unlike banks, they cannot access cheap money through current and savings accounts, but this disadvantage is more than offset by their low operating costs. For example, NBFCs don’t have to make provisions for Cash Reserve Ratio and Statutory Liquidity Ratio.

“Then, their larger presence in semi-urban and rural markets gives them an edge over private sector banks,” adds Pande of Cholamandalam DBS Finance. Also, unlike banks, many NBFCs, like Indiabulls, avoid using direct sales agents and focus on interacting directly with customers. This, too, cuts out a layer of costs.

The ambitions of NBFCs are best exemplified by IBFSL. Launched seven years ago by three IITians— Sameer Gehlaut, Rajiv Rattan and Saurabh Mittal—it has scaled up its business from an internet trading platform to one that provides a whole gamut of financial services like home, SME and commercial vehicle loans and also advances against shares and properties. It is now eyeing long-gestation businesses like life insurance, asset management and commodities trading, for which it is has applied for a licence. “We are committed to building scale in every business we are in,” says Banga.

New kids on the block Several large business houses are entering the NBFC segment. Tata Capital After the Tata Finance fiasco, the House of Tata is back in the financial services business. It has placed Praveen Kadle, who was earlier CFO of Tata Motors, in charge of the venture. Future Capital Holdings Kishore Biyani has big dreams in the financial services sector. He is eyeing everything from selling insurance to advancing consumer loans. Former Goldman Sachs CEO (Institutional Business) Sameer Sain is heading the new venture. Biyani, Birla, Bajaj Birla Finance Kumar Mangalam Birla is all set to revive his financial services business and has roped in former Prudential Asia CEO Ajay Srinivasan (who launched Prudential’s operations in as many as nine countries) to revamp the group’s financial services sector strategy. Bajaj Finance Rahul Bajaj is considering a separate financial services business that will include his group’s two successful insurance ventures and its auto finance arm for his younger son Sanjiv Bajaj. If that happens, the group may expand into other lucrative areas like private equity, investment banking and asset management. Source: BT Research

Ask any NBFC about them encroaching into the domain of banks and they retort that development financial institutions have also reinvented themselves as banks; then banks themselves have moved away from pure working capital and short-term lending to the retail segment.

“It’s a free-for-all. There are no private territories anymore,” says the CEO of a regional NBFC. Indiabulls and Reliance Capital offer big-ticket housing and SME loans, hitherto the preserve of banks, and the latter, which operates through subsidiaries like Reliance Money, has emerged as a big player in gold retailing. It is also the largest private sector partner of Western Union for money transfers in India. “We do more than 100,000 transactions per month and are next only to India Post in money transfers,” says Sudip Bandyopadhyay, CEO, Reliance Money. Then, Reliance Money is also among the top 5 in the industry, including banks, in mutual funds mobilisation space. “We mobilised over Rs 10,000 crore in 2007-08,” he says.

New players

The growing opportunity in the NBFC segment is attracting many new players. The Tata Group has revived its financial services business and Kishore Biyani’s Future Group is also entering the sector in a big way. “We have already seen momentum building up in our financial services business,” says Pankaj Razdan, Deputy CEO, Aditya Birla Financial Services, which recently roped in Ajay Srinivasan, former Chief Executive (Asia), Prudential Plc, to scale up its business. Kadle of Tata Capital, meanwhile, is banking on the largely untapped SME market.

“We are tapping business partners in the Tata Group ecosystem, like suppliers, service providers and distributors, with whom we share a long-standing relationship,” he says.

Today, NBFCs are benchmarking themselves against banks in terms of service, quality of manpower, reach and research. “The favourable regulatory environment places NBFCs in a better position than banks in several lines of business,” says a banker. In gold retailing, for instance, NBFCs are allowed to buy back the gold they sell; this is not permitted for banks. “Only a miniscule minority of customers actually returns to sell the gold they buy from us, but the fact that we’re willing to buy back the gold provides customers with a comfort factor,” says Bandyopadhyay.

Similarly, in the life insurance space, a bank can tie up with only one insurer whereas NBFCs can have as many partners as they want. “We pick the best possible products in the market and offer customers a bouquet of choices depending on their requirements and profile,” says Bandyopadhyay, whose company has tie-ups with 17 asset management companies, five life insurers and four general insurers.

Two years ago, RBI allowed NBFCs to distribute mutual funds products; this is now a major source of fee income of almost all NBFCs. Then, RBI rules stipulate that the capital market exposures of banks—defined as direct investments, proprietary holdings, MFs and advances to brokers— be at 40 per cent of net worth. As a result, banks cannot fully tap the potential of this very lucrative segment of high margin business loans, leaving the field open to NBFCs.

Banking ambitions

A year-and-a-half ago, Reliance Capital was rumoured to be interested in taking over ICICI Bank and Indiabulls actually bid for United Western Bank. But empirical evidence suggests that it isn’t easy for NBFCs to make the transition.

The magnets The following emerging segments, apart from the more traditional loans business, are attracting NBFCs. Insurance: In June 2000, RBI allowed NBFCs to enter the insurance business Credit Cards: In July 2004, the apex bank allowed NBFCs to launch their own credit cards, either on their own or in association with another NBFC or scheduled commercial bank. Distribution of Mutual Funds Products: In 2006-07, RBI permitted NBFCs to distribute mutual funds products as agents of MFs. Money Changing and Money Transfer: In 2002, RBI included the money changing and money transfer business in the list of businesses that NBFCs could carry on. Source: RBI

Centurion Bank, which emerged from 20th Century Finance, got into serious financial trouble before it was revived by Rana Talwar and his team. Talwar recently decided to merge it with the stronger HDFC Bank. Then, Uday Kotak’s Kotak Bank hasn’t been able to replicate its success as an NBFC. And Ashok Leyland Finance, which merged with IndusInd Bank, has a portfolio that’s for a long time been skewed towards commercial vehicles.

The other side of the argument is that today’s NBFCs are no longer like the single-product companies of the past. They are, this argument goes, universal banks by another name. So, it is now easier for them to convert into banks.

For the time being, though, RBI seems to be in no hurry to facilitate this transition. That means NBFCs, which are now competing headon with banks in several new verticals, have to tread very carefully, especially on pricing. The booming economy of the immediate past enabled their easy entry into new segments, but if the economic cycle turns, the going could get tough for many NBFCs, especially given the comparatively higher cost of their funds. Most importantly, they will have to carefully price the risk they are taking. Too high a price and they will become uncompetitive; too low, and they will lose the cushion they need to cover the loans that may turn sticky. Ramesh Iyer, CEO, M&M (Mahindra & Mahindra) Finance, cautions: “You should never compete on price in the financial services sector.”

But given the bullishness, and competition, in the sector, such sage advice is likely to fall on deaf ears. Meanwhile, the NBFC juggernaut will continue to roll.