Credit and finance for MSMEs: NBFCs have become a central part of the Indian financial system serving the needs of individuals and SMEs. It accounts for around 9 percent of total financial sector assets, making it the third largest segment after commercial banks and insurance companies.
By Gaurav Anand
Credit and finance for MSMEs: NBFCs are now increasingly preferred by borrowers as they complement but also replace banks in their ability to reach remote areas, make faster decisions, prompt services and expertise in niche segments. They act as back-up institutions when the banking system is under stress by expanding the reach of financial services and improving its resilience. However, this industry requires regulatory watch and lending rate control to thrive economically and provide an architecture to support the financial needs of growing small and medium businesses.
Given the nature of the transaction, NBFCs also bear the burden of inherent risks, including excessive leverage, withdrawal of the bank’s priority lending sector status from NBFCs, overreliance on funding. wholesale capital market or banks, vulnerability to credit risk, insufficient regulatory recovery tools, and insufficient central bank profits and increased procyclicality. The challenges faced by NBFCs are many, but the Reserve Bank of India (RBI) has addressed the challenges and made measurable decisions for non-bank institutions.
The operations of NBFCs are regulated by the Reserve Bank of India Act, 1934, with priority given to the benchmarking of regulations and their alignment with banking sector regulations, thereby reducing regulatory arbitrage. In line with new regulations aimed at bringing regulatory parity with those of banks, NBFCs have been divided into four layers based on their activity, size, perceived risk, and scale-based regulations to help preserve stability. financial. The base layer with an asset size of less than Rs 1000 crore, the middle layer with an asset size of 1000 crore and above, and a top layer comprising the top ten NBFCs in terms of asset size. Along with this, RBI also changed the NPA classification for NBFCs to 90 days instead of 180 days and the net ownership fund requirements for these NBFc were increased to Rs 20 crore from Rs 2 crore which reduced to its turn the stress of credit risk and maintain sufficient liquidity for a smooth transition during the moratorium.
Despite easy accessibility, maximum funding, remote coverage, and improved regulation, NBFCs face failure by charging higher interest rate and processing fees than banks due to its more funding options. easy and practical. However, they cannot offer interest rates higher than the ceiling rate set by the RBI. The current cap rate is 12.5 percent per year. Here are the reasons for the increase in loan interest rates by NBFCs:
Fund raising : Unlike banks, NBFCs do not have a banking license and are not permitted to accept deposits from the public. They therefore have to raise funds through various sources such as bank loans in the form of term loans and also from FDI by selling commercial papers or six-month debt securities. Thus, the NBFC’s interest rate must cover its cost of borrowing and the spread.
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Unavailability of the overdraft facility: Since NBFCs do not offer banking business, they cannot provide the overdraft facility. This makes their interest payable higher than basic banking institutions.
Wider loan eligibility criteria: The applicable LTV (loan-to-value) loan eligibility percentage will be higher for NBFCs than for banks, as the former includes stamp duty and asset registration, unlike banks.
Relaxation in the CIBIL score: NBFCs have less stringent policies for relying on CIBIL scores as a criterion for offering loans, unlike banks which require at least 750 credit scores. This allows low-income segments and the informal sector, which have no credit history, to access loans. This risk causes NBFCs to charge a higher interest rate.
Faster process and documentation: NBFCs have a faster turnaround time for processing loans with minimal documentation compared to banks. The flexibility and convenience are offset by a higher processing rate.
It is important to note that the RBI has looked into the question of how non-bank institutions value their loans and called for greater transparency in the process of setting the interest rate. Additionally, the central bank mandated anchor rates for NBFCs to keep the lending process smooth, convenient, and affordable for borrowers. NBFCs have become a central part of the Indian financial system serving the needs of individuals and SMEs. It accounts for around 9 percent of total financial sector assets, making it the third largest segment after commercial banks (64 percent) and insurance companies (14 percent).
In recent years, NBFCs have become the largest receiver of funds overtaking banks on a net basis. The huge credit growth of NBFCs in the wake of asset quality pressures has underscored their role in the Indian financial system. Remaining unserved and underserved by banks, NBFCs are now focusing more on developing innovative products and services focused on niche markets at regulated interest rates. Partnerships with fintechs have also reduced costs, increased customer base, reduced customer portfolio risk, and increased credit penetration for NBFCs in the growing economy.
Gaurav Anand is the CEO and co-founder of Namaste Credit. The opinions expressed are those of the author.
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