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Bank of the Future

Does Demonetization Spell Digitization for Indian NBFCs?

 
March 23, 2017

According to a BCG study, the contribution of the non-banking financial corporations (NBFCs) to the Indian economy has gone up from 10 to 13 percent, and is projected to increase in the coming years. NBFCs particularly cater to SMEs and rural segments, helping drive large-scale development and growth of Indias economy. The November 2016 demonetization drive has impacted these segments significantly. Let us see how.

The Demonetization Dampener

Micro finance institutions cater to customers who do not have access to banking services, and mainly use a cash-based operating model. The recent currency demonetization drive in India has severely impacted small-scale and manufacturing industries, leaving them cash-strapped. The consequent liquidity crunch has made it difficult for small enterprises to make payments to self-help groups (SHGs), entrepreneurs, and farmers. This has plummeted the collections of the micro finance institutions, which used to be a major portion of the NBFC portfolio.

The resultant slowdown of the economy has resulted in reduced sales for small businesses, thus impacting their loan repayment ability. NBFCs involved in lending to businesses against property (LAP), vehicle financing, gold loans, and so on have taken a visible hit. Property prices have fallen, resulting in holding off on new real estate projects and launches. All these factors have led to a subdued demand for NBFC loans. In case of NBFC LAPs, with the increase in loan-to-value ratio, non-performing assets (NPAs) on the NBFC books are expected to rise.

Reprieve from RBI

The RBI has increased the repayment period on loans by providing additional 60 days for customers to clear their dues. This will prevent reporting of loans as bad loans due to collection problems caused by demonetization. As NBFCs are not allowed to raise deposits for lending purposes, they are also dependent on funding from other financial institutions. This relaxation from RBI is a much-needed relief for NBFCs, as they can continue to borrow from bigger financial institutions for lending.

A Silver Lining for NBFCs

Although NBFCs have suffered due to demonetization, but this event has also opened up several opportunities as well. Microfinance institutions have traditionally faced immense competition from the informal banking system in rural areas, which offers flexible, fast loans, of course, at very high interest rates. These institutions specifically stand to gain because the informal lending segment has suffered a big blow due to demonetization. It could be years before the informal banking agents reach a decent liquidity situation to be able to lend again. Considering this, NBFCs can devise strategies to fill the void and bring the self-help groups, entrepreneurs, and farmers into the fold of the formal banking system.

NABARD is playing an active role in easing the liquidity problem in rural areas, by granting loans to deploy PoS machines in villages. The apex development bank is also conducting awareness drives to educate the unbanked population on how to use RuPay cards at PoS machines. Additionally, the government has announced a series of measures, including providing subsidies to farmers for availing loans at lower rates. This will result in demand generation, in turn, helping the NBFCs increase their customer base substantially.

The Future is Digital

NBFCs have so far relied on the cash-based model and have had little incentive to shift to digital lending, or to educate their customers on the benefits of formal banking. With currency demonetization leading to cash crunch in rural areas, NBFCs will have to tweak their business model slightly. In moving away from cash-based lending and repayments, microfinance institutions will need to reduce paper intensive processes and enable digital payments. This will reduce the costs involved in processing and servicing loans.

Also, lending to SMEs will improve since there will be more transparency in the financial books of SMEs given that all transactions will get recorded in bank account statements. In the longer run, this will be instrumental in improving NBFC balance sheets. If planned right, NBFCs can capitalize on this demonetization and look to increase their customer base as well as their bottom-line. This will also provide the much needed stability to the rural sector of the Indian economy. What do you think?

Harish Kumar Dhilip Kumar is a Functional Consultant with the Banking and Financial Services (BFS) business unit at Tata Consultancy Services (TCS). He has more than eight years of experience with expertise in the commercial and consumer lending space. Harish has previously worked with leading multinational banks in the area of commercial lending, and has developed product offerings for EdgeVerves Finacle suite of financial solutions. He holds a Bachelors degree in Industrial Engineering from the University of Kerala, India.