NBFCs, or Non-Banking Financial Companies, are not banks, as the name indicates. They do not rely on CASA or Current Account Savings Account deposits to support their operations. As CASA deposits are only relevant to banks, the RBI issues licences to banks allowing them to take funds from the general public. NBFCs do not have such advantages, which mean they require alternative sources of money supply that are greater than the interest rates given by banks on deposits, which range from 4% to 6%.
Because these financial entities, unlike banks, are unable to raise money, they must raise funds at a higher interest rate, forcing the barrier rate on their funds to rise in lockstep to maintain Net Interest Margins of 1-3%. As a result, NBFCs are looking for other approaches for capital distribution in order to generate a greater return (in order to take on an elevated risk pattern).
Why is venture funding important in NBFC?
Any NBFC startup which is registered under RBI to serve its business objective needs fundraising. NBFC is always one of the most popular sectors for the investor as if you manage NBFC by use of technology and big data the risk in business reduce to 5%. Whenever a venture capitalist starts funding for a startup at SEED stage or startup stage or later stage, the financing plan depends on the current market scenario and business growth expected by the founders.
In the modern NBFC business, funding and fundraising act as the major resource which supports the growth of a startup. To achieve the goal of a startup, it is important to ensure the right allocation of fund to each business segment. Fundraising agenda needs to be carried by founder on a regular basis. There is no end of fundraising process for a startup.
Sources of Funding in NBFC
- BANK FINANCE TO NBFCS
Banks are permitted to provide working capital and term loans to all NBFCs that are registered with the RBI. According to the latest RBI statistics, banks invested Rs 1.9 lakh crore in the non-bank sector between September 2018 and February 2019, increasing their portfolios by over 40%.
- FUNDING IN NBFC FROM PRIVATE EQUITY AND VENTURE CAPITAL
Private equity and venture capital firms are still interested in NBFC. Because banks are burdened by large non-performing assets (NPAs), investors have begun to focus on non-banking financial companies (NBFCs) and alternative banking structures like small finance banks for capital deployment, as they continue to cut into state-run banks’ market share. Experts believe the investment validates India’s expanding financial services ecosystem’s potential.
Sources of business funding in NBFCs
Non-Banking Financial Companies (NBFCs) can raise capital from a variety of deposit sources, including:
- Long-term loans at low interest rates
Once an NBFC has accumulated enough assets to deploy in its activities, it can request for a long-term loan from a bank. Because of the nature of CASA deposits, banks lend at considerably cheaper interest rates, which benefits NBFCs. These loans can be secured or unsecured by using Government Securities, and they can be paid back in a structured or bullet schedule. In addition to the asset part of the Balance Sheet, NBFCs must record the repayment of long-term loans. To obtain a big quantity of capital at competitive interest rates, NBFCs need a high credit rating.
- Foreign Direct Investment (FDI)
Foreign investment is one of the finest funding choices for NBFCs. In 1991, during the Indian economy’s post-liberalization phase, a massive surge in foreign investment in NBFCs was seen. Foreign investment of up to 100% is now authorised under the automatic route in FDI. As a result, foreign investors do not need RBI or FIPB clearance to participate directly in NBFC’s.
- Issuing commercial paper available for short-term loans
Commercial Paper can be used by NBFCs to raise capital. It is a short term unsecured Promissory Note issued by the financial Companies that have duration of 3 - 12 months. NBFC’s with a minimum net worth of INR100 crores are eligible to list Commercial Papers as per the RBI.
- Issuing Bonds
Issuing Bonds allows NBFCs to get significant funds at minimal prices. It is a typical method that aids in lowering the rate on funding sources. The Bonds’ coupon rate is selected to match the NBFC’s rating profile. Bonds have a maturity profile that matches to the NBFCs’ interest payments schedules. Bonds can also be sold to ordinary investors, which give NBFCs a significant edge when it comes to bond placement.
- Loan securitization
Between October 2018 and September 2019, NBFCs raised INR 2.36 lakh crore by selling their loans in the market through securitization. Securitization is a popular strategy used by HFCs and NBFCs to manage liquidity, generate capital, and rectify ALM mismatches.
Measuring and effectiveness of fundraising
The following are the most important considerations to make while raising funds:
- Investigating the asset-to-liability mismatch;
- Bringing the mismatch down to a minimum.
In this scenario, assets are described as investments made in the activities of an NBFC as a financing company through equity, debt, or structured products, while liabilities are considered as the amount due to parties that have given the funds for the financing activity. The difference in interest rates between the two causes an arbitrage, resulting in a Net Interest Margin. The value produced by the arbitrage is derived from the NBFC officials’ skill and experience in identifying appropriate areas for investment at a greater risk-reward ratio and providing exceptional profits in the Indian or corporate environment.
- Treasury and Rupee Resources Departments
The method of increasing the money supply is mostly handled by the rupee resources department, which manages long and short term instruments used by NBFC to balance supply and demand. The Treasury department is responsible for disposal, any asset liability variation, and call or money market instruments to be determined when the funds are parked after the resources have been raised and the funds have been received by the firm.
- Asset/Liability Matching in an NBFC: Key Performance Indicators
Treasury and rupee resources departments depend on the preceding critical risk variables for the same purpose:
1. Liquidity Risk
There is a risk that an investment will be unable to be easily marketed or sold to a 3rd party in order to minimise losses.
2. Interest Rate Risk
Interest rate risk while raising funds, which has a negative impact on the Net Interest Margin and wears down the value of the NBFC’s net worth.
3. Foreign Exchange Risk
The risk of incurring losses as a result of adverse exchange rate fluctuations, like the demonetization that occurred in 2016, particularly when holding an open position, whether spot, forward, or a combination.
4. Equity Price Risk
For the equity investments made by the NBFC, there is a risk of a loss on account of public or private equity shares held in the portfolio. NBFCs manage and regulate their treasury operations based on the numerous risks they face, rather than the specific type of financial instrument they deal with. Broad IT systems are put in place to assess these risks as well as the value at risk, and the investment is trimmed appropriately as needed. At all times, a risk of default and a loss due to default are assessed, which changes as the profile of the organization in which the investment is made changes. The VaR technique would be used to assess the risk of a trading position or portfolio being solidified owing to changes in market interest rates and prices over a set period of time.
Variations in market interest rates have an influence on the institution’s banking balance sheet’s economic worth. Given an NBFC’s diverse loan product offerings, it would be prudent to calculate an IRR on the banking book that considers the impact of rate fluctuations on both earnings and economic value. The Treasury Mid-Office may compute simple maturity gaps, re-pricing gaps, and duration gaps as a starting point taking the size of the data into account.
Asset Liability Committees in Non-Bank Financial Companies (NBFCs)
The ALCO’s primary responsibility would be to manage the organization’s liquidity and interest rate risk. These committees are generally led by the company’s CXOs to keep an eye on costs that might spiral out of control and have an influence on profitability, especially in a down market.
Role of the ALCO –
- Risk-return planning on the balance sheet, as well as interest rate and liquidity risk management.
- Estimation of a base rate and product price for loans and advances.
- Determining a desired maturity profile and asset and liability combination that can be put on in the future.
- Developing an interest rate stance and deciding on an interest rate risk management plan for the future.
- Reviewing the funding approach to decrease the danger of running out of cash.
Liquidation – Treasury Ops
- Treasury operations are divided into three categories: front, middle, and back office. The clearing house for matching, running, and regulating market risks is the Treasury Front Office within the institution. It also provides investment support for the assets and liabilities generated by an NBFC’s regular operations. FEDAI, FIMMDA, and other regulatory codes of conduct must be adhered to by all dealers actively engaged in day-to-day trading operations. The Internal Stop Loss Limit must also be maintained by the dealers.
- The back office ensures that all transactions are completed correctly. Furthermore, timely settlement of all dealing accounts is a critical control to guarantee accurate risk exposure identification.
- The mid office serves is an on-site tracking department as well as providing value-added assistance to front-office operations. It serves as a self-contained risk monitoring system.
Why Every NBFC startup raises foreign funding?
100% foreign funding is allowed without any restriction in all type of NBFC other than Deposit taking NBFC
How can you complete the process for funding in NBFC with Enterslice?
- Connect with Enterslice
Contact the Enterslice team to discuss your company’s particular requirements. The required discussion takes 20-25 minutes.
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We’ll assign a professional Account Manager to help you understand your business, give the best options, and guide you through the entire process once you’ve discussed your requirements with us.
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