Major challenges faced by NBFCs & their solutions

Ashish M. Shaji

23 Jul, 2020

In the last few years, the financial sector has undergone a significant transformation, and the NBFCs (Non-Banking Financial Companies) have been an essential component in that change. NBFCs have continued its growth, and its contribution to the Indian GDP has gone past the contribution by banks.

Therefore, NBFC registration in India may look like an excellent option for entrepreneurs. However, there are certain challenges faced by people while starting NBFCs. In this article, we shall look at those challenges faced by NBFCs. 

Challenges faced by NBFCs

NBFCs have been capturing market shares and have made rapid progress than the banks, but small NBFCs have faced difficulty in establishing themselves due to the presence of a few prominent players in the NBFC market.

There are a number of challenges faced by NBFCs. Some of the major challenges are discussed below:

• Challenge of funding due to the absence of refinancing option

In India, banks have many options for refinancing. Likewise, housing financing companies also have refinancing alternatives, and it refinances from the regulator of Housing Financing Companies.

However, the NBFCs are dependent on banks or the capital markets for raising resources. This is quite unfavorable to the sustainability of the growth of NBFCs. Moreover, it is also to be noted that the funds flow from these sources can run dry anytime.

• Challenges faced in obtaining NBFC license

The process of procuring the NBFC license is quite complicated. The process involves complicated documentation procedures and approval from the Reserve Bank of India. The Reserve Bank regulates the process, which needs to be followed by the NBFCs in order to get registration.

• Complicated NBFC compliances in India

When the NBFC is incorporated, it is also required to follow a number of compliances. NBFC compliance varies from one type of NBFC to another. So the challenge arises when a person running a company of loans and advances, etc., it becomes increasingly tough to carry all aspects together. It also becomes challenging to know when the prescribed returns are to be filed and how it is to be filed.

• Lack of flexibility in loan classification of NPAs

The Non-Performing Assets (NPA) are quite relevant for big powerhouses, but businesses with irregular cash flow face an adverse impact on delay in payments.

Classification under NPA and flexibility in scheduling is essential. The NPA classification should be based on assets financed.

• Absence of a statutory recovery tool

The lack of a statutory recovery tool with NBFCs is another challenge hounding the NBFCs for long.

• Several representative bodies

In the current situation, there are a number of representative bodies. It must be understood that the NBFC sector is still in its early stages. Therefore, setting a single representative body could be an ideal thought. It is also vital that every segment is represented adequately in the apex body that facilitates the balanced growth of NBFCs.

• Lack of capacity building

It is essential that the NBFCs create a receptive ecosystem for capacity building on collective as well as on an individual basis. It lacks in present NBFCs, and the gap must be filed as soon as possible.

• Disparate tax treatment

There lies a great inequality in the tax structures for banks vs. NBFCs like Tax deduction at source, dual taxation on lease/hire purchase, etc.

• Lack of defaulter database

NBFCs are susceptible to credit risk due to the lack of vital information. Additionally, there is a need to bring the essential legislative amendments in order for these companies to leverage the utility payments database in the credit assessment process.

• Stripping of priority sector status to bank lending to NBFCs

This is one of the major challenges faced by NBFCs. The priority sector status to bank lending to NBFCs should be restored. Therefore the collaboration model between the NBFCs and banks ensures the credit flow to those sections of the society that are underserved. It will help NBFCs to create assets and wealth in rural parts of the country. The Reserve Bank of India can put a cap to route a fixed percentage of total bank lending priority through NBFC.

• Minimum mandatory credit rating for NBFC

It is now obligatory for a deposit accepting NBFCs to get investment-grade credit. It will make them eligible for accepting deposits. If the rating of the NBFC is downgraded below the minimum investment grade rating, it can’t take public deposits. Moreover, it is required to report to the RBI regarding its position.

The solution to the challenges faced by NBFCs

In this segment, we shall take a look at solutions to tackle the challenges.

• The NBFCs can partner with Fintech players as their offerings are faster, cheaper, and better in terms of lending, brokerage, payments, and credit scoring. 
• In case of an NBFC just starting its operations, a business plan is vital, and proper monitoring should be done.
• A company must implement a risk management framework as there are numerous risks that a company might face. It will help the company to identify the potential threats to the organization.
• A professional group of consultants can be hired for NBFC documentation, license, and Compliances. It will help in tackling the obstacles which are faced by the NBFCs.
• Co-originating lending can help NBFCs to avoid funding risk and many other issues.

Conclusion

Also, read: Check List for an NBFC Business Model.