Technology Adoption Key To NBFC Success

After a tough period of survival, the NBFCs are back in the reckoning with improved system liquidity and strong capital buffers that have helped majority of NBFCs to disburse loans 


The NBFC sector plays a pivotal role in the Indian economy and often the health of this sector is touted to reflect the health of our financial system. Worsening NBFC sector performance also is a harbinger of poor economic realities. Shreya Chaware analyses the NBFC sector’s performance while also sharing its overall outlook.

NBFC stocks have taken a backseat at a time when technology and pharmaceutical stocks have begun to dominate since 2020. Come 2021 the buzz was around the commodity stocks and the PSU stocks along with the crypto currencies. While the action-packed story of equity markets was earmarked by various sectors that stood to gain from the lockdown and rising raw material prices, the financial sector was amongst the worst hit along with hospitality and travel and tourism. 

What steadied the ship for the financial sector in general and NBFCs in particular is the slew of measures announced by the RBI. The decisions to infuse liquidity and some timely tweaks in the way NPAs could be recognised proved to be useful for a majority of NBFCs with good balance-sheet and adequate capital adequacy. After a tough period of survival, the NBFCs are back in the reckoning with improved system liquidity and strong capital buffers that have helped majority of NBFCs to disburse loans.

"NBFCs have done well in managing the impact of pandemic as well the fallout of IL&FS and Franklin Templeton. Post the IL&FS scenario, on the liability side the liquidity pipeline is very strong with positive ALM. Relationship with banks, financial institution and the share of bank borrowings has risen. Balance-sheets are in a better position than a year ago. Operationally, most large NBFCs are now more cost-efficient. The spread between of cost of funds for large and small NBFCs is rising and so we should expect more consolidation in the industry, with large NBFCs becoming even larger and cost-efficient. On the downside, the impact of the second wave lockdown is expected be much more severe than the first wave. The second wave will lead to credit costs remaining elevated in FY22 for NBFCs. The second wave of the pandemic will lead to credit costs remaining elevated in FY22 for NBFCs. The impact of this on NBFC asset quality would be an adverse impact on MFI lending stocks. The impact on housing loan and gold loans remains unharmed due to secured lending business."

-Bonanza Portfolio

NBFC Performance and Outlook

On bourses the performance of NBFCs has been muted over the past three years; however, the performance in the past one year has been more or less in line with the broader markets. The 34 stocks in the NBFC sector that we studied delivered on an average 131 per cent return in the past one year while in a three-year period the average performance of these NBFCs with a total market capitalisation of `8,04,446 crore remained flat. However, if we consider the average performance of the same set of NBFCs over past five years the returns have been nearly 15 per cent.

Within the NBFC space the outlook remains grim for commercial vehicle loans and for small microfinance institutions. However, those companies offering housing finance, tractor loans and gold finance, the outlook remains steady for the coming quarters. The sector is expected to grow by closer to 10 per cent YoY in FY22 aided by superlative growth of housing finance companies. The NPAs scenario is expected to improve as the economy recovers even as it is expected that the operating costs will normalise to the prepandemic levels for NBFCs. On the NPA front, one can expect moderate addition to the gross non-performing assets and some lower softer delinquencies.

Conclusion

In all likelihood, the year 2021 could be the one when we see strong NBFCs with niche positioning improve their margins and performance while small NBFCs with balance-sheet issues may continue to struggle. The collection efforts for a majority of NBFCs are paying off even as the collection efficiency promises to show improvement. The loan defaults have surely come down and as the vaccination drive improves and economic activity hits normalcy, the loan defaults can be expected to come down. Innovative business practices that include more and more digital usage may lead to unprecedented efficiencies leading to untapped opportunities.

Most of the NBFCs have leveraged technology and redoubled efforts on the digital side which augurs well for the sector. Increasingly, NBFCs are seen adopting tools that aid risk-based pricing and lending decisions which may unlock the growth opportunities for the sector. The importance of data has been realised by the NBFC players, prompting them to invest in technology infrastructure which is expected to provide actionable insights. Forward looking analytics can be achieved with the help of cloud technology and use of artificial intelligence and machine learning tools which will help in effective client acquisition and improved credit decisions and efficiency while also optimising costs.

One can also expect an uptick in demand for rural product loans while the agriculture sector thrives and remains least impacted by the lockdown. It is clear that there are some excellent investing opportunities in the NBFC sector even as the competitive landscape will shape the kind of business models that companies adopt. For investors it thus becomes very important to understand the business models adopted by various NBFCs. It will be wise to stick with known names in the sectors with proven capabilities and strong balance-sheets.

More weightage can be given to those NBFCs where there is scope for margin expansion. Without doubt the NPA figures need to be closely watched to identify a probable winner. Also, those investors who will be able to decipher the benefits from the new technology adoption by NBFCs and have a strategic understanding of the steps adopted by the NBFC management shall be able to spot winners in the NBFC sector quite easily. Gold loan companies and HFCs stand out in terms of their attractiveness within the sector.