The Year 2009 for Non Banking Financial Companies in India
A developing economy like India always craves for financial resources. Demand for credit is great and often organized traditional financing institutions (like banks and financial institutions) do not meet such demand thus creating a space for other types of financing. Money lender is an age old institution filling such space. Opening up of economy gave a further boost to the demand for credit. At this juncture, NBFCs (Non-Banking Financial Company), which basically were better organized money lenders happened in large number. A NBFC is a company that is engaged in the business of loans and advances, acquisition of shares/stock/bonds/debentures/securities, leasing, hire-purchase, insurance business and chit business. NBFCs do not include any institution whose principal business is that of agriculture activity, industrial activity, sale/purchase/construction of immovable property.
NBFCs in India have played a useful role in financing various sectors of the economy, particularly those that have been underserved by the banks. In fact, many banks are forming NBFCs to take advantage of their greater flexibility in dealing with customers. There are, of course, some persistent problems for NBFCs, apart from deposit-taking. These relate to flexible handling of their capital issues. Both SEBI and the RBI need to revisit their case for relaxations with sympathy, especially since they are rated and supervised. These specific relaxations are more a matter of confidence-building.
The Year 2009 - Not so promising for NBFCs:
The major class of NBFCs, the Asset Financing NBFCs reported a fall in growth this year. The fall in demand for loans from the automobile sector and increased levels of asset quality slippages, have reduced the profit growth of most non-banking financial services (NBFC) players.
Bajaj Auto Finance, Cholamandalam DBS Finance, Sundaram Finance, M&M Financial Services and Shriram Transport Finance, the five prominent NBFCs, have aggregately seen net profit grow by 32 per cent over FY08. The profit picture may look skewed due to much higher profit growth registered by Shriram (57 per cent) and Bajaj (64 per cent). Chola DBS saw a decline in profit growth (-28%).
The automobile slowdown that became pronounced between October 2008 and March 2009 may have negative effects on the NBFCs’ books for the next couple of quarters. However, the Reserve Bank’s recent relaxation in asset repossessing norms may benefit the NBFCs. An auto sector revival (supported by encouraging sales data in over the last couple of months) may boost the disbursements of loans.
Change in policies - the need of the hour:
Given the recent economic turmoil, the FDI regulations in the NBFC space might need a little bit of fine tuning. Under the existing FDI policy, investment in an NBFC is permitted subject to $50 million capitalisation to be brought within a period of 24 months.
Considering the overall slowdown, the sector could do well with contracting this cap to, say, $30 million or by extending the period to, say, 36 months. This might encourage flow of capital in NBFCs. Further, the list of 18 permitted activities falling under the automatic route does not include investment activity; investment advisory activities are however included. It is urged that investment activity be also included, as it is anyway a permitted classification under the RBI regulations.
Parity with banks
One of the most repeated pleas of NBFCs on the direct taxes front is the issue of parity with banks and housing finance companies in the areas of allowing provision on non-performing assets as a deduction. This provision, made in accordance with the prudential norms of the RBI, can be claimed as a deduction for tax purposes under Section 36(1)(viia) of the Income-Tax Act, subject to overall limits. The banking industry is independently representing that these limits be freed.
Similarly, income deferred in respect on non-performing assets of NBFCs is unjustly subject to tax on the basis of ‘accrual’. However, banks in general are well protected by Section 43D of the I-T Act. This dichotomy is drawing the attention of the courts, including the apex court. A concrete solution is clearly an amendment to the tax laws to ensure parity.
Tax deduction at source (TDS) is an effective machinery to collect taxes in advance, also results in litigation. Interest paid to an NBFC on borrowings is subject to a 22.44 per cent tax deduction at source. Banks, cooperative societies, public financial institutions, etc., are given shelter under Section 194A of the I-T Act, which does not extend to NBFCs. While tax laws provide for a nil or lower withholding, the tax department has shown resistance in granting this relief. As a result, the yields on lending have dropped significantly.
With some NBFCs still actively engaged in leasing of passenger cars, office equipment, etc., the TDS on the rentals paid by the lessee to the leasing company is a dampener. The rate of deduction in accordance with Section 194-I of the I-T Act erodes the entire margins on the transaction.
Leasing as a product has its own sets of complexities like accounting guidelines, deferred tax, etc., and the TDS hurdle imposed from 2007 has virtually knocked the oxygen out of the what was a revival of sorts to this product in the recent years.
An authority for NBFCs:
The Government should come forward to set up an authority exclusively to take charge of the development of the industry. The authority could set itself as an objective that over a specified period of time, (say) ten per cent of financial assets (which today would be Rs 4 lakh crore) should be under the management of NBFCs. Such an initiative would revive the performance of NBFCs.
The year Ahead for NBFCs
As Mr. T. T. Srinivasa Raghavan, Managing Director, Sundaram Finance Ltd. pointed out, “we fail to realize that what we need here in the financial services sector is an Indian model, given our diversity and the fact that our challenges are very different from anywhere else in the world. With the turn of events over the last 12-18 months, it can be expected that we will finally realize that we must seek Indian solutions to our challenges.”
Banks should look at their relationship with NBFCs as a wholesaler-retailer relationship and not as competitors. While NBFCs are only a small number, if this business model of a wholesaler-retailer evolves, it will certainly help in expanding the reach of credit delivery to the far corners of the country, especially to the under-served markets. The success of the last mile delivery depends on the various players working as a continuum.