Page 93 - DMGT512_FINANCIAL_INSTITUTIONS_AND_SERVICES

Financial Institutions and Services

Notes 7.2.2 Prospects

The forte of NBFCs has been credit delivery to areas not covered by banks and Financial Institution
(FIs). By virtue of there past experience NBFCs know the tacit needs of retail customers much
better and with more sensitivity than others do. As traditional boundaries between different
categories of financial intermediaries are disappearing, NBFCs have to face stiff competition in
retail financing specially from banks and FIs. Does it mean that NBFCs should move into the
forte of financial intermediaries (i.e. working capital loans and term lending)? Given the fact
that financial intermediary's business is dominated by the attendant risk and the banks' and top
rung FIs' ability to raise funds at low cost, if NBFCs compete head-on, then they will be at loss
owing to their high cost of mobilizing funds.
Though the evolutionary process of the NBFCs has made them nimble and agile, their main
handicap is the small size of their balance sheet, resources and their distribution reach, which is
region specific. The limited cushion available to them in times of difficulties pose a great threat
to their very survival and restrict their opportunities to grow. The biggest challenge in front of
NBFCs therefore is to increase their size. This could be by merging with each other.
There is just not place enough for so many small micro NBFCs. Therefore, those who still try to
hang on without concrete plans or core strengths, are bound to die a very painful death. The
newer layers are likely to bring in tremendous financial muscle. In the take-off period, they can
afford to be over aggressive and their product sophistication is also likely to be superior.
Given such a situation, NBFCs must realize the plain fact that a certain amount of market share
and size or a "critical mass" is vital for sheer survival. The NBFCs, in the next couple of years,
will be faced with the relentless logic of Darwinism. A process of elimination is certain.
But a financial intermediary cannot be closed down like a cement plant or a soap factory as they
have a set of financial claims both inward and outward with differing maturities and risks. So
the most practical method would be consolidation by mergers. World over, troubled banks and
non-banks have been bailed out by the mergers and acquisition route. This is apart from the
numerous mergers done on purely commercial considerations. There should therefore be a call
for immediate measures to facilitate mergers of NBFCs with “profitable” companies to avoid
the risk of default in repayment of public deposits, bank, institutional funding and to make
NBFCs grow in future.
Apart from mergers, other options waiting for NBFCs are to change the tracks and explore new
areas. They have to extend their product portfolio to include asset management companies,
housing finance firms and to venture into newly opened insurance sector for private participation.
Examples of such initiatives are launch of associate company of Sundaram Finance to disburse
housing loans, which has been the domain of HDFC and LIC Housing Finance. Entry of Kotak
Mahindra Finance Limited, Sundaram Finance and Lakshmi General Finance into the insurance
business is another example. In the medium term most NBFC's are looking at developing niche
areas and concentrating on fee based income to offset the loss in fund based activities. Examples
include the move of Ashok Leyland Finance to launch a finance portal that would be used to sell
products of other financial intermediaries and to use its skill in collection to derive a pure
service income. The benefits of such horizontal integration would be a diversification of the
company's revenue stream which goes with the old saying of putting one's egg in different
baskets.
Another new area which can be explored by NBFCs is the Internet.

Example: Recently the Morgan Stanley Dean Witter Internet research emphasized that
Web is more important for retail financial services than for many other industries.

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