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
