They never had it so bad. The nation's NBFCs are grappling with a host of problems that are threatening their very survival. Fund sources are drying up, their public image continues to remain tarnished, lending has become riskier, non-performing assets are on the rise, margins in retail finance are headed southwards, banks and financial institutions with retail focus are becoming fierce competitors, RBI is tightening its regulatory noose, tax laws continue to be unfair, asset recovery laws and procedures are inadequate... Well, the list of woes seems to be endless.

One only hopes it is not death knell for the NBFC sector. For,NBFCs have a role to play in an economy such as India's. Their evolution only reiterates their vital role in the Indian economy.

Boom to bust
NBFCs began their long-trek as support companies. Their primary functions included acting as fixed deposit collection centres and working out leasing deals for corporate clients. Initially, most of these NBFCs were concentrated south of Vindhyas. Why, several South-based NBFCs began life as nidhis or chit funds.

And bulging deposits pushed up confidence levels leading to NBFCs foraying into greener pastures such as investment banking, bills discounting, consumer durable finance, auto finance, leasing and hire-purchase, among others. Finally, NBFCs had arrived on the nation's financial scene.

Then came the boom, a period of unreined growth. Mushrooming of NBFCs became the order of the day. With rising demand and low entry barriers, almost every corporate entity floated an NBFC. After all, it took just a couple of computers, a couple of telephone lines and some office space to jump on to the NBFC bandwagon.

Streams of debt apart, unencumbered equity finance also came from a less-regulated primary market. The party went on for sometime. The markets were impressed with the NBFCs' reach, flexibility and adaptability.

All of a sudden, it became fashionable to float a financial services company. The eighties saw dime a dozen NBFCs springing up. The number of NBFCs rose from 7,063 in 1981 to 41,000 in 1996. During July 1997, there were as many as 37,000 applications from NBFCs for re-registration. And NBFC deposits during the decade ended 1998 grew faster than bank deposits. What started as a trickle turned into a deluge.

The party ground to an abrupt halt. The spanner in the works: the Rs 806 crore fraud perpetrated by the infamous CRB Capital Markets. And things began taking a turn for the worse. The regulator, the Reserve Bank of India (RBI), began tightening the noose around the NBFCs.

And problems began exploding like so many shooting stars. The result has been unpleasant. NBFCs have been logging in negative growth in assets and deposits during the last couple of years. As against Rs 27,000 crore in 1996, the deposit base of NBFCs today has whittled down to Rs 10,000 crore.

Identity crisis
What are the problems that NBFCs face? A major problem post-CRB is that the NBFCs are faced with a growing negative public perception. The RBI directives that followed the CRB scam transformed the NBFCs into pariahs overnight. Investors apart, even banks began shying away from NBFCs. Says K V S Manian, chief operating officer of the Mumbai-based Kotak Mahindra Finance: "Even good NBFCs are suffering due to the negative perception. Clubbing all NBFCs together is wrong." So much so, even fundamentally sound NBFCs are finding it difficult to raise funds at competitive rates. Currently, NBFCs are going through a painful identity crisis.

Meanwhile, NBFC spreads are getting squeezed. The villain: rising incidence of asset-liability mismatch. Most NBFC liabilities are short-term funds and these funds are largely locked up in assets with a maturity of two years and more.

What the NBFCs need are steady deposit renewals and inflow of fresh deposits to tide over such crisis. Alas, post-CRB renewals have declined. In a bid to lure depositors, NBFCs are offering higher interest rates and this is inflating the cost of their funds. It is an unenviable Catch-22 situation.

Stifling regulations
RBI regulations are also responsible for queering the NBFC pitch. For the last two years, RBI has been consistently bombarding the NBFC sector with stifling and inconsistent regulations. Thanks to this regulatory rigmarole, investors and depositors are more confused today.

For instance, s.372 of the Indian Companies Act requires financial service companies to seek triple approvals for every financing deal: NBFCs have to obtain sanctions from the general body of shareholders, from the board of directors and from the financial institutions. This is too onerous.

Not just that. Exemption extended to industrial finance companies under the earlier provision is now limited only to companies "exclusively" engaged in industrial finance. Since most NBFCs are engaged in assorted financial services such as car finance and consumer durable finance apart from industrial finance, they do not qualify for this exemption.

Slow recovery
Recovery of receivables is another area that is keeping the NBFCs worried. Thanks to non-recovery or slow recovery of receivables, NBFC funds are blocked. Judicial process for recovery of advances is also very slow and inefficient.

At times, cases are dismissed on flimsy technical grounds. And it takes years for the courts to decide recovery cases filed by NBFCs. Yes, the dice is heavily loaded against the lender.

What is needed is a credit information bureau and effective networking among lenders. These should prevent a defaulter availing financial accommodation from other NBFCs. What is alarming is the steady rise of cheque-bouncing incidents. With courts moving slow to decide such cases, as much as Rs 7,000 crore is locked up in disputes.

No one seems to be doing anything about this state of affairs. The judicial system is warped. The number of judges inadequate and the recovery laws biased. And, the regulator seems to be more bothered about streamlining liabilities of NBFCs and not their assets. There seems to be no respite coming from any quarter.

Banks on the turf
Adding to all these woes, banks and financial institutions have forayed on to NBFCs' turf and are proving to be more muscular competitors. Host of banks, Indian and foreign, have started offering financial services such as car finance on more competitive terms.

Financial institutions such as ICICI have taken the retail initiative and is proving to be a real challenge for NBFCs. This incursion has already pushed small NBFCs out of their traditional areas.

One such traditional financing activity where NBFCs are steadily losing out to banks and financial institutions is car finance. The car finance segment is estimated to be Rs 8,000 crore large and is fast growing. Last year, this segment posted a growth of 60 per cent.

Car finance arms of foreign banks are able to source deposits at the bank rate and lend at competitive rates of 12 to 15 per cent. This is not the case with NBFCs, whose cost of borrowing is high at 15 per cent. How then can they compete effectively? Specialised niche financial institutions too pose a serious threat to NBFCs.

Problems aplenty
There are other problems as well. NBFCs face serious sectoral risks, thanks to their increased exposure to fixed asset financing. Says Mahesh Thakkar, executive director of the Mumbai-based Association of Leasing and Financial Service Companies (ALFS): "Financing the small-scale sector and consumer finance have become riskier business for NBFCs. Leasing has become unattractive, thanks to unfriendly recovery laws."

A vital link
What should be the plan of action now? NBFCs are a vital link in the financial supply chain and can add tremendous value to financial services. NBFCs play a major role in mobilisation of savings through widening of their resource base. They reach out to areas where banks have no presence and bring borrowers and lenders together. It is thus essential to work out a win-win gameplan for NBFCs so that they can not only survive but succeed as well.

One major pre-requisite for this to happen is a strong regulatory and supervisory structure. Such a structure should have teeth to check errant NBFCs and at the same time allow the players enough operational freedom. The nation's judicial system needs to be beefed up and made more efficient. Lender-friendly recovery laws alone can help NBFCs replenish their treasury and make finance available to credit-worthy borrowers. This should have all-round positive effects on growth, employment and government revenues.

Other areas that need attention are a sound capital structure and management quality in NBFCs. Says S K Mitra, managing director of the Mumbai-based Birla Global Finance: "Capital, management and being in the wrong business are responsible for the present state of affairs among NBFCs."

Greener pastures
True, NBFCs need to explore right business opportunities waiting to be tapped. If they care to look around, there are many such opportunities. NBFCs can invade the operational turf of banks and offer specialised and customised products in investment banking and brokerage businesses. They can leverage their relationship with the corporate sector and offer them fee-based services such as forex advisory services, issuing of letters of credit and cash management.

NBFCs are cut out for offering fee-based services related to capital and debt markets. They can intermediate and act as investment consultants, portfolio managers, investment bankers, merchant bankers, stock brokers, primary dealers in the money market and satellite dealers in government securities. Importantly, these activities do not call for a fund base and can bolster the bottomlines of NBFCs. Says Dilip Pendse, managing director of the Mumbai-based Tata Finance: "There is tremendous growth potential in sectors such as commercial vehicle finance, two-wheeler finance and consumer durable financing. NBFCs can tap the growing opportunities in distribution of financial products such as mutual fund schemes and government securities."

Mergers and acquisitions (M&As) are also emerging opportunities for NBFCs. Disinvestment in public sector undertakings is going to throw up lot of M&A opportunities for NBFCs. Exploring new opportunities should then become an on-going exercise for NBFCs. For instance, Kotak Mahindra Finance is looking at the unexploited consumer finance segment. Says Manian of Kotak Mahindra Finance: "Consumer finance is a large area which is not exploited." And Tata Finance has tied up with the American Express Bank and is venturing into the credit cards business.

What these examples suggest is that: NBFCs need not look at banks as threats. Why, NBFCs can act as retailers in financial services. Says Thakkar of ALFS: "NBFCs can share a mutually-beneficial relationship with banks. NBFCs can assist banks in credit organisation, asset securitisation and recovery of overdues."

Alongside, NBFCs should put in place effective product delivery standards and result-oriented marketing strategies. Says Manian of Kotak Mahindra Finance: "In financial services, you cannot be innovative for long as products get replicated immediately. So, one should improve on service and have low delivery costs. NBFCs should beef up customer service and geographical service standards."

Net initiatives
Internet is another area that NBFCs should look to shore up their business volumes. And financial services are technology-intensive and amenable to the Net. Says Mitra of Birla Global Finance: "Net is absolutely essential for reach." NBFCs are waking up to the joys of the Net, meanwhile.

Kotak Securities and Birla Global Finance are already selling their financial products on the Net. Adds Mitra: "We have tied-up with major sites for referrals and we will earn a brokerage. With this strategy, competition can generate business for us."As the Net spreads its tentacles far and wide and as competition hots up in the financial services sector, smaller NBFCs have little chance of survival.

These NBFCs need to become niche players. Says Manian of Kotak Mahindra Finance: "Smaller NBFCs will have to become niche players in product or geographical or non-fund based business categories." Yes, smaller NBFCs would do well to offer backroom services for the financial sector.

Niche areas
Offering asset reconstruction services to other NBFCs and extending micro-credit are profitable niche areas that NBFCs should look at. For instance, Kotak Mahindra Finance has ventured into asset reconstruction services. Says Manian of Kotak Mahindra Finance: "The response to our asset reconstruction scheme has been good. We have two transactions on hand and we are talking with several other clients."

The services that NBFCs can offer in asset reconstruction could be advisory nature. That is precisely what Kotak Mahindra Finance is doing. This NBFC is charging a fee for the contract in two parts: the first part represents a retained fixed fee and the other part represents a fee dependent on the success of the project.

As the nation's recovery system is complicated and courts inefficient, asset reconstruction services have tremendous potential for NBFCs. For instance, Kotak Mahindra Finance is taking advantage of the ambiguity in legal approaches and suggesting the right recovery strategy for its clients.

Micro-credit is another promising niche area for NBFCs to explore. Micro-credit calls for excellent logistics management, an extensive distribution network and ample volumes. Most NBFCs may not be equipped enough to venture into micro-credit. But, those NBFCs with rural distribution networks can certainly use the micro-credit strategy to survive and succeed.

Micro-credit could be the key that can open up a plethora of business opportunities down the value chain. It can not only financially accommodate a particular activity, but can also lend a boost to an array of support services and infrastructure-providers. For instance, micro-credit to the mango growers of Ratnagiri can be extended to packaging firms, mango exporting houses, mango transporters, irrigation equipment suppliers to mango orchards and so on.

Thus, micro-credit opens up new financing opportunities for the NBFC concerned all along the supply and value chains. This strategy should ensure that NBFCs do not starve of fund deployment opportunities. Moreover, micro-credit strategy has a social objective to it. It helps in an all round development of the geographical area concerned. In essence, micro-credit is mixing business with social responsibility.

So, the nation's beleaguered NBFCs should work towards converting the ongoing crisis into an opportunity. The coming shakeout in the NBFC sector is sure to throw up quite a few tempting opportunities for players with vision and foresight.

NBFCs should fasten their seat belts, concentrate on restructuring, identify emerging opportunities and sketch out blueprints for future growth. Says Mitra of Birla Global Finance: "For the past couple of years, there has been enough talk about the problems faced by NBFCs. It is getting monotonous. I feel the sky is clearing for NBFCs and let us talk about opportunities and growth."