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Indian financial firms find themselves in deep trouble

Nikhil Faleiro in Bombay

It could hardly be considered an auspicious year for the non-banking finance companies. Ever since CRB Capital Markets collapsed, leaving hundreds of investors groping in the dark for their money, non-banking finance companies have come under a great deal of scrutiny by the regulatory authorities and rating agencies. Listed below are some of the recent developments:

* ITC Classic, a non-banking financial company, is on the verge of bankruptcy. Depositors are saved when the Industrial Credit and Investment Corporation of India purchases it in November.

* The Credit Rating and Investment Services India Limited downgrades the ratings of 14 major non-banking financial companies on doubts about their profitability in the last week of October.

* Former Reserve Bank of India Governor C Rangarajan agrees with the Parliamentary Standing Committee at a meeting in October that urgent steps are needed for regarding the functioning of the non-banking and plantation companies. According to Rangarajan, these companies should come under the purview of the RBI Act as any company that offers interest above 15 per cent should offer an explanation to the authorities concerned.

* In September, the RBI bars JVG Finance Ltd and Prudential Capital Markets against either accepting fresh deposits or renewing existing public deposits. As per the ban both these companies have no option but to redeem investors deposits as and when each deposits matures. In mid-December, DSJ Finance is barred from accepting further deposits and rating firms downgrade the company to non-investable level.

The average consumer seems gripped by a fear psychosis about the viability of the NBFCs, whose numbers exploded two years ago due to the high demand for consumer finance, and today stands at over 40,000. An increasing number of depositors have in recent times withdrawn their funds from the NBFCs, which combined hold approximately Rs 500 billion with them. And despite brave attempts by the NBFCs at damage control to retain their customers, most NBFCs have lost approximately 20 per cent of their deposits.

The present state is result of many events starting with the loss of public confidence due to the CRB scam, pressures on the bottomline due to bad business last year, poor recoveries particularly from the corporate sector, and accounting norms requiring provisioning against non-performing assets, among others. In this probably worst phase of the business cycle for NBFCs, around 50 medium-sized entrepreneurs are known to have quit the business altogether. Another major contributor for the present state of affairs has been the dismal state of the primary insurance market. In India, investors are not covered by insurance.

The NBFCs today face twin problems on the funding side of the business -- a slowdown in deposit mobilisation, and difficulties in obtaining significant increases in bank finance. This has led to a fall in deposits renewal rates, which is likely to cause an asset-liability mismatch for NBFCs who have locked their funds in relatively long-term assets.

Kotak Mahindra Finance Ltd Executive Director Shivaji Dam says, "The asset quality of NBFCs has deteriorated during the last few years with corporate finance witnessing defaults over the past few years."

On the asset side, the internal rate of return for NBFCs is down to 17 per cent from 30 per cent last year while on the liabilities side, the cost of deposits has fallen to 14 per cent from the normal 20 per cent. CRISIL has said that it is of the opinion that there will be a tremendous squeeze on margins and profits. Moreover, the increased competition in all segments of NBFCs operations will cause lending rates to decline sharply, which will also hit the long-term profitability of the NBFCs.

Alpic Finance Senior Manager Arun Nevaskar seconds the view. "NBFCs are working in a difficult environment which is bound to affect our profitability in the long run," he says.

Incidentally, the companies downgraded include big names such as Kotak Mahindra Finance, Anagram Finance, Alpic Finance, 20^th Century Finance, Ashok Leyland Finance, VLS Finance, and Whirlpool Finance. The main flaw was their declining profitability, and increasing delinquency in the lease and hire purchase portfolio.

CRISIL has come in for criticism. According to Mahesh Thakar, executive director, Association of Leasing and Finance Services, "CRISIL's move to lower the ratings is extremely pessimistic and will harm the industry in the long run. Moreover, at the rate that regulatory bodies are targeting NBFCs, the shakeout has started in the industry. By the end of the next year we expect not more that 100 to 120 large NBFCs to survive the onslaught. Small companies are unable to withstand the intense pressure and are slowly closing shop, and this in turn spells doom for the industry."

An earlier blow against NBFCs was struck by the Securities and Exchange Board of India in September when SEBI banned NBFCs from carrying out merchant banking and fund-based activities like leasing and purchase.

From SEBI's point of view, the directive makes sense because by combining both these functions, the NBFCs were regulated by both SEBI and RBI. Forcing them to split will now ensure smoother inspection and make detection of frauds easier and avert scams similar to the CRB case. CRB was, incidentally, involved in both merchant banking and raising deposits without anyone knowing about the same.

However, SEBI's directive has not gone down well with most NBFCs involved in both the operations. With the economy witnessing tight monetary conditions and the costs of funds extremely high, income earned from managing debt and equity issues or providing advisory services helped shore up profits and subsequently, leasing activities provided a tax shelter for income.

The SEBI diktat has put many large NBFCs such as Lloyds Finance and SBI Capital Markets in a difficult position as they will not be able to disinvest their fund-based activities from merchant banking. SBI Capital Markets, a leading merchant banker with a large lease portfolio, has already declared that it cannot separate the two businesses during 1996-97 because 52 per cent of its total income of Rs 1.41 billion came from leases from which the company has claimed depreciation and set it off from other income.

Similarly, other merchant banking subsidiaries such as Allahabad Bank, Bank of India, and Bank of Baroda too are finding the SEBI order difficult to implement. On the other hand, it makes little sense for companies which earn only marginal amounts from merchant banking to separate the the section as it will not benefit in the long run.

For instance, in 1996, Apple Finance earned only Rs 48.5 million from the merchant banking division out of total income of Rs 2.2 billion. Says Executive Director A K Janak, "If the returns form equity are sufficient then it is worthwhile to set up a separate decision, if not then it would be advisable to close down the merchant banking business."

According to the Centre for Monitoring the Indian Economy, the total net profit of 141 NBFCs, whose audited annual accounts were available, has declined by 25 per cent from 1996-97. And the total net profit of 1,336 manufacturing companies showed a smaller decline of 15 per cent in the same period. Similarly, 14 large NBFCs, each with an income of Rs 1 billion and more, showed a lower growth of 19 per cent in income and a decline in the net profit for the year.

With the NBFCs at receiving end, it will take a considerable amount of effort to dig itself out the present mess that it has fallen into. But whether there will be any customers around as and when that happens, only time will tell.

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