After immense discussion on P2P lending regulations in India, the Reserve Bank of India issued gazette notification dated 18th September 2017 stating that peer to peer companies who provide loan...
Over the past few years, the NBFC in India has undergone a drastic transformation, and the sector has now become a systemically essential component of the financial system. Despite the demonetization in the country, NBFCs have maintained consistent growth.
The contribution of NBFC to the country’s GDP is more than that of the banks. Therefore, we can say that NBFCs are going to be the backbone of the country in the upcoming years.
Hence, starting an NBFC in India could be one of the greatest options entrepreneurs with a high budget can ever opt for. But there are a few challenges that people often face when starting NBFCs. So, firstly, it’s important to discover them and find a way to overcome them.
Issues and Challenges in the NBFC Sector
Even though the NBFC has been capturing market shares and making rapid progress than from commercial banks, a few prominent players have largely dominated the NBFC market. Small NBFCs are struggling to ramp-up their operations and lend sustainably.
There are several factors due to which NBFCs struggle. Some of the major challenges and issues in the way of starting an NBFC in India are as follows:
a) Funding issue due to the absence of refinancing option
Banks in India have several options for refinancing such as RBI, NABARD, EXIM Bank, and SIDBI. Likewise, Housing Financing Companies (HFCs) also have the refinancing alternative, and it refinances from NHB (National Housing Bank), the regulator of HFCs.
However, NBFCs have to hinge on banks, competitors, or the capital markets for raising resources every time. In turn, this could be unfavorable to the sustainability of the NBFCs growth like in the case of distress. Furthermore, the flow of funds from these sources could dry up without much notice.
b) Complication in obtaining NBFC License
The process of procuring an NBFC license is quite difficult. The reasons for the same are the complicated documentation and approval required from the Reserve Bank of India. RBI governs the process of NBFC registration and has set several standards for obtaining the same.
Apart from the documentation, there are several criteria that an NBFC applicant must satisfy. They are-
- Composition of the Board of Directors: It means at least one of the directors of the company should an experienced person with a financial background. For example, he/she must have worked in the Bank.
- Quality of Capital: A net worth of Rs. 2 crores is mandatory to start an NBFC in India which is quite high. However, the most important thing to consider is the quality of capital. Whether it is white money or black. Therefore, thorough verification is done on the source of capital applicant brings.
- No Conviction: Another most important thing and the challenge in starting an NBFC in India. The director must not be convicted of any charge. If he/she is, then the person can’t be the director of the company.
c) Difficult compliances for NBFC in India
Once you have incorporated your NBFC, you need to follow its compliances strictly. There are a number of NBFC compliances for different types of NBFCs which they have to file quarterly, half-yearly, and annually.
Therefore, if you are running a company of loan and advances, etc., then it becomes quite tough to look at all the things at own. Furthermore, it becomes really difficult to figure out how and when to file the prescribed returns.
d) Absence of flexibility in the classification of loan NPAs
For large corporates, the NPA (Non-Performing Assets) norms are quite relevant. However, businesses with irregular cash flow have a cascading impact regarding all the delays in payments.
Although, in the revised categorization, assets are re-categorized; therefore, classification under NPA and greater flexibility, w.r.t scheduling is much required. The classification of NPA norms must be based on the assets financed instead and the borrowers’ profile or uniform system of asset classification.
e) Lack of statutory recovery tool
After the asset classification norms are revised, something which still lacks is the recovery tool at par with banks. However, NBFCs today lack statutory recovery tool available.
f) Limited leverage ratio for NBFCs-ND with assets sizes less than Rs. 500 crores
Small NBFCs are exempted from the maintenance of the Capital Adequacy Ratio (CRAR). But they can’t exceed the leverage ratio beyond 7 which is quite restrictive. Furthermore, such NBFCs borrow largely from financial institutions and banks which in turn carry out due diligence on the NBFCs that borrow.
g) Several representative bodies
The NBFC sector is at the development stage. Therefore, in the interest of developing its various segments in a harmony, setting a single representative body could be a better alternative. However, one must always ensure that every segment is represented adequately in such an apex body that promotes the balanced growth of the NBFC sector without any inner conflicts.
However, in the present situation, there are a number of representative bodies. For instance, the Finance Industry Development Council for AFCs, Association of Gold Loan Companies for Gold Loan NBFCs, etc.
h) Requirement of capacity building
NBFCs need to work on creating a receptive ecosystem for capacity building on both a collective and individual basis. And that’s what NBFCs are nowadays lacking and need to work up on.
i) Disparate tax treatment
It’s a well-known fact that there exists a big inequality in the tax structures for Banks vs. NBFCs. For example, TDS (Tax deduction at Source), Dual taxation on lease/hire purchase, and income recognition on NPAs. However, the current legal framework for NBFCs doesn’t allow a tax deduction for the non-performing assets.
j) Scarcity of defaulter database
NBFC doesn’t get defaulter lists from Banks. In turn, this leaves NBFCs susceptible to credit risk on account of the lack of crucial information. Moreover, there is a requirement for bringing the essential legislative amendments so that these companies can leverage the utility payments database in the credit assessment process.
k) Removal of Priority Sector Status to Bank Lending to NBFCs
It’s one of the biggest issues that NBFCs face. The Priority Sector status to Bank Lending to NBFCs must be stored. Hence, the collaboration model “wholesaler/retailer” between the NBFCs and Banks ensures the credit flow to under-served sections of the society. This, in turn, helps NBFCs in creating assets and wealth in semi-urban and rural parts of the country. However, RBI could specify a cap to route a maximum of a fixed percentage of the total bank lending priority sector through NBFC.
l) Minimum mandatory credit rating for deposit-taking NBFC
As per the revised regulatory framework, it is obligatory for NBFCs accepting deposits to get investment-grade credit. This will make them eligible for accepting public deposits from any of these six rating agencies- CARE, CRISIL, FITCH Ratings India Pvt. Ltd, ICRA, SMERA, and Brickwork Ratings India Pvt. Ltd.
In case the rating of any NBFC is downgraded to below the minimum investment grade rating, then it can’t accept public deposits. Further, it must report the RBI regarding its position within fifteen working days.
Solutions to the above NBFC challenges
Now that you are have encountered the challenges, here we have provided solutions to almost all of them.
1. Co-Originating Lending for funding issues
With the help of Co-originating lending, the NBFCs can avoid the funding risk and such several issues. Further, with co-origination, such companies can leverage their balance sheets which will not only improve their return on equity (ROE) but will also let them provide a better rate and experience to the customer.
2. Partner with Fintech Players
Fintech companies have always gained promising opportunities and the ability to enhance the capabilities of the lender. Moreover, their offerings are better, faster, and cheaper across several domains such as lending, brokerage, payments, personal finance, and credit scoring.
The Fintech players can help NBFCs significantly drive competitive advantage and boost capabilities in a crowded market. NBFCs partnering with Fintechs can widen their customer database, increase their operational efficiency, etc.
3. Business plan and continuous monitory
For a beginner company/NBFC, NPAs are a big hurdle to the organization’s growth. Therefore, even before you start, you require a great business plan and need to monitor every activity continuously.
4. “Name and Shame” guarantors for loan defaulters
Along with Banks, NBFCs too can join the naming and shaming of wilful loan defaulters. According to bankers, the company needs to publish the name, address, and photographs of the guarantors if they don’t clear the dues within the 15 days of the notice which contains the details of the original borrower.
5. Risk management framework
A company, especially a start-up, is always at some kinds of risk. Hence, it’s important for the company to implement a risk management framework. It will aid the organization with a structured process to help the company identify the potential threats to the organization.
Furthermore, it helps the entity to define the strategy and tactic to minimize or eliminate the impact of such risks.
6. Hire consultants for NBFC Documentation, License, and Compliances
Yes, it is that simple. Consultants like Enterslice and Swarit Advisors, which are considered a brand for NBFC registration and compliances can help NBFC applicants to excel in their business.
These consultants have good hands-on tackling every obstacle in the path of NBFC licensing, documentation, and compliances. Dealing with RBI is really difficult but professionals make this easy for you. Hence, you must hire one professional for obtaining NBFC license and complying with the compliances of NBFC.
It’s evident from the above discussion that starting an NBFC in India is an arduous task. There are several hurdles in the way that entrepreneurs must overcome. Because the process of NBFC registration requires approval from the RBI, so it becomes hard to acquire the license. Furthermore, the NBFC documentation process is quite complicated. Apart from the licensing, following the compliances of NBFC is also a challenging task in itself.
Therefore, we suggest you contact the most trusted professionals in the market for getting the NBFC license. Besides, if you have any queries regarding the NBFC registration process, please leave the comment below. We will get back to you very soon.