Non-Banking Finance Companies

Non-Banking Finance Companies

Companies that allocate their resources to the cross section

of society comprising individuals, families and businesses in
providing financial services

Heterogeneous group of financial intermediaries of varying

size and provide a range of services
 Non-Banking Finance Companies

A company registered under the companies act, 1956 and

is engaged in the business of loans and advances,
acquisition of shares /stock/ bonds/ debentures/securities
issued by government or local authority or other securities
of like marketable nature, leasing, hire-purchase,
insurance business, chit business but does not include any
institution whose principal business is that of agriculture
activity, industrial activity, sale/ purchase/ construction of
immovable property
 Non-Banking Finance Companies

Discussion Issue

?
How are NBFCs distinct from commercial banks?
Do NBFCs complement/supplement the services provided
by banks or compete with banking companies?
 NBFCs Versus Banking Companies

NBFCs cannot accept demand deposits

NBFCs is not a part of the payment and settlement system

and as such cannot issue cheques to its customers

Deposit insurance facility of DICGC is not available for NBFC

depositors unlike in case of banks

While banks are incorporated under banking companies act,

NBFC is incorporated under company act of 1956
Principal Characteristics of NBFCs
 SWOT Analysis of NBFCs
Strengths

 High on service aspect

 Strong last-mile approach
 Focus on recovery
 Easy and fast appraisal and disbursements
 Regional linkages
 Able to generate higher yield on assets
 Attained critical mass in terms of size
 Own employees versus DSAs
 SWOT Analysis of NBFCs
Weaknesses

 Weak in urban markets

 Weak credit history of most NBFCs
 Largely restricted to the regional markets (say South India)
 Weaker risk management and technology systems
 Too much of diversification from core business
 Higher regulatory restrictions
 SWOT Analysis of NBFCs
Opportunities

 Augmentation of capital and leveraging for growth

 Large untapped market, both rural and urban and also
geographically
 Demographic changes and under-penetration
 New opportunities in credit card, personal finance, home equity
and distribution of mutual fund schemes
 Tie-up with global financial sector giants
 Blurring gap between banks in terms of costs of funds
 Securitization, to liberate funds to fuel asset growth
 SWOT Analysis of NBFCs
Threats

 Weak financial health of many of the NBFCs

 High cost of funds
 Asset quality deterioration may not only wipe out profits but also
net worth
 Entry of foreign players in post-2009 scenario
 Growing retail thrust within banks
 Growth Path for NBFCs in Future

• Larger NBFCs with critical mass

• Focus on returns and profits : identifying various sources of
revenue streams
• Increase reach, capital, branding
• Obtaining the global expertise and products–innovative products
• Tie-ups with global financial giants
• Reduction in cost of funds
• Multiply its size; look to convert into a bank
Structure of NBFCs
NBFCs on the basis of Principal Activity
Non-Banking Finance Companies
REGULATORY NORMS NON-BANKING FINANCE COMPANIES
PRE-REQUISITE FOR STARTING NBFCS
PUBLIC DEPOSIT ACCEPTANCE NORMS
ISSUES CONCERNING NBFCs
FINANCE/INVESTMENT ISSUES
GOVERNANCE ISSUES
INFORMATION SYSTEM ISSUES
PRUDENTIAL NORMS
REASONS FOR DECLINE OF NBFCs
REVIVAL OF NBFCs
STRATEGIC OPTIONS FOR NBFCs
NBFCs INTO INSURANCE
REGULATORY REQUIREMENTS FOR JOINT VENTURE ROUTE
 Some lessons from CRB

 Ignore high profile people, over-ambitious and controversial management

groups or promoters

 Avoid companies that frequently go to public for funds. such companies are
usually bound to land-up in a financial mess  sooner or later.

 Avoid companies that promise atrociously high rates of return which cannot
be justified or deployed at lighter rates without the acute risk of default.

 Avoid companies having excessive exposure to financial investments or

equity market and whose business or lending is not backed by assets. crb
was one such company which did not have asset backed investments.

 Avoid companies with multi-activity base that do business with their own
divisions. for instance, CRB was involved in securities trading, broking,
merchant banking, mutual funds, portfolio management, research etc. and
this led to problems. in such a set-up, losses get merged into a big pool of
earnings and the red signal is seen only at a later stage.
Equipment Leasing Companies
 Leasing

In simple terms leasing means economic use of an asset

without ownership

A rental agreement that extends for a year or more and

involves a series of fixed payments -Brealey and Myers
 Leasing Defined

A contract or an agreement under which a person (lessee)

acquires the right to make economic use of a specific
asset for a certain period of time for a consideration
called lease rental without owning it
Why leasing?
Principal parties to a leasing agreement
Market segment wise classification of equipment leasing companies
Market segment wise classification of equipment leasing companies
 Leasing Segments

Issues
What is relevant: Industry or equipment?
And what do we mean by the best equipment to lease?

Most active leasing segments are those where Risks are

lowest (or profits highest) for the lessor and which offer
better terms to the lessee
 Most Easily Leased Assets
Most easily leased equipment can be repossessed if
• Easily moveable
• Easily identifiable (or registered)
• Lessee may be denied use

Low equipment risk

• Easily resold (active secondary market)
• Not excessively specialized
• Useful life remaining is significant
• Marketing/reselling cost are low
• Usage/technical characteristics predictable
 Classification of Leased Assets

• General assets
• Specific asset
 Classification of Leased Assets
Specific Assets
• Assets designed and fitted to serve the needs of a specific user
• Have low value in an alternative use
• More specific an asset is, the harder it is to refit it for resale
and buyer pays low prices for it
• To compensate for this loss of value in adverse situations,
lessors demand high price at the outset
 Classification of Leased Assets
General Assets

• Used by a broad range of users with a few if any adjustments

• Assets may be general within an industry or have much
broader use
• Such assets can be used across a broad range of industries
without material adjustments
Most Active Leasing Segments
 Essential Features of Leasing

• Leasing is a contract (Sec. 10 of the Indian Contract Act) : must

satisfy all features of a valid contract such a competent
parties, free consent, lawful consideration, lawful object etc.
• Competence of the lessor and the lessee
• Subject matter
• Delivery of goods
• Purpose
• Return of specific goods
• Possession
• Consideration
 Contents of the Lease Agreement

• Period covered by the lease

• Provisions for payment of taxes
• insurance
• Maintenance expenses
• Provision of renewal of lease or purchase of an asset by
the lessee at the expiry of the lease
• Timing and amount of periodic rental payments covering
the term of the lease etc.
Leasing Company Business Model
Types of Lease Finance
 Finance Lease

• Lessee identifies equipment and pays the full value of the

asset together with the interest within a period of the life of
the asset
• The lessor recovers during the lease period the cost of
purchase, administrative cost, other expenses and his profit.
• Lessee is normally responsible for maintenance, insurance,
tax etc.
 Typical Finance Lease

Information, demonstration,
after-sales services

Technology choice Lessee

Supplier

Sale of equipment Lease payments

Lessor Rental of equipment

Cash payment of equipment
 Operating Lease

• Lessor identifies and purchases equipment and provides other

services such as maintenance, repairs, technical advice,
• training lessees’ staff etc.
• Lease on period to period basis
• Lease usually for short periods to one or more lessees
• Asset is returned after use by giving a notice
• Higher rentals
 Finance Lease

As per AS19, Leases that meet any one of the following

requirements

• The lease agreement transfers ownership to the lessee before

lease expires
• The lessee can purchase the asset for a bargain price when the
lease expires
• The lease lasts for at least 75 percent of the assets’ established
economic life
• The present value of the lease payments is at least 90 percent
of the assets’ value
 Leveraged Lease

• Tripartite arrangement between the lessor, the

lessee and the lender (financier)
• Lessor borrow funds to acquire the leased assets
• Leased assets are hyp0thecated to the lender
• Primarily used for big ticket leasing. examples are ships,
aircraft, containers etc.
 Sale and Lease Back

• Existing assets sold by owner to the lessor and taken back on

lease basis
• Transaction may be for old revalued or newly acquired assets
• Lessee get possession for use of assets as well as cash
Reasons to Engage in Sale and Leaseback
 Cross Border Leasing

• Lessor / lessee domiciled in different countries

• Complex form of leasing involving flow of funds
between nations
• Exchange control requirements – requires Reserve
Bank approval
 Cross Border Leasing
The conventional model
Syndicate of Debt financier
financier’s equity

Equity holder in SPV/SPE dividend Lease rental assigned

for repayment of debt

SPV Payment for equipment

purchase
Lease rental (Lessor)

Equipment supplier
supplies equipment
Importer (lessee)
 Loans versus Finance leases versus Operating Leases

Criteria Loan Finance lease Operating lease

Legal ownership of Borrower Lessor Lessor

equipment

Securing the Typically mortgage on Equipment ownership Equipment ownership

transaction equipment and
additional collateral
Equity/security deposit High Medium Low

Responsibility for Borrower Usually lessee Usually Lessor

maintenance and
insurance
Risks (damage, residual Borrower Usually lessee Usually Lessor
value risk etc.)

Cancellation option NA Usually not available Usually available

 Risks in Leasing Business

 Cargo Risk-Transporting leased assets

 Repossession risk; particularly while leased goods are abroad

(cross border leasing)

 Regulatory risk: inability to recover and bring back leased

assets for commercial or political reasons
 Credit Risk-Non-payment of lease rentals

 Supplier’s risk-non-payment by leasing company

 Equipment risk-failure of goods – warranty