NBFC

How do NBFCs get funding?

How do NBFCs get funding

A Non-Banking Financial Company (NBFC funding) is a company that performs the business of loans and advances, acquiring shares, bonds, stock, insurance business, or hire-purchase business but does not include those businesses whose principal objective is agriculture or agriculture-related activities, sell or purchase of any goods or carrying on any businesses of sale or purchase or construction on any immovable property.

NBFC funding has no dependence on C.A.S.A (Current Account Savings Account) deposits for raising its funds. The CASA deposits are only essential for traditional banks, whereas banks are generally licensed to take funds from the general public. Usually, the NBFC funding method doesn’t get much benefit from taking funds from the customers, which connotes they require an alternative source of funds that is practically greater than the interest rate given by the banks on deposits, which generally ranges from 4% to 6%.

Table of Contents

Sources of raising NBFC funding method

Funding helps the NBFC funding method to grow with the prospects. There are two types of sources of funding.

Bank finances to NBFC funding method

Banks are authorized to facilitate working capital and term loans to all the NBFC funds that are registered with the R.B.I. According to the latest R.B.I. statistical data, the bank’s outstanding credit to non-banking financial companies rose by 27.6 % yearly to reach 13.4 Lakh Crore INR. This growth can be associated with several other factors, including the base effect, the improvised financial position, and advancing visibility in the NBFC funding sectorial development.

Funding private equity and venture capital to NBFC funds

Private equity and venture capital institutions are still desirous of the NBFC. It can be seen that the banks are always under the burden of high non-performing assets (N.P.A.s), and investors are now focusing on the non-banking financial companies and also on alternative banking structures such as small bank financing for the organized placement of the capital as they continue to get bifurcated into state-run banks’ market share. The experts have faith that the investment will lead to the expansion of India’s financial ecosystem.

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Sources of business for NBFC funding method

NBFC funds can raise capital through various deposit sources, the following-

Long-term loans at low-interest rates

Once the NBFC funding method has proportioned enough amount of assets on its activities, it can request a long-term loan from the bank. Due to the nature of CASA deposits, banks usually lend at a cheaper rate, which generally benefits NBFC funds. These loans can be secured or unsecured with the help of Government Securities, and they should be paid back to the source in a structured or bullet schedule type. Concerning the asset part of the balance sheet, the NBFC should take the records of the repayment of long-term loans. If the NBFC wants to avail large quantities of capital at competitive interest rates, then it needs to have a high credit rating.

Egress of the Foreign Direct Investment

As has been seen after the liberalization of the Indian economy started from its core in 1991, there has been a vast increase in foreign investors’ interest in the Indian NBFC sectors. The Automatic Route can be applied to foreign investors without any approval from the Foreign Investment Promotion Board (FIPB) or R.B.I. before making the planned investment.

Issuance of Bonds

The NBFC funding method also involves issuing bonds to attract significant funds at a minimal price. It is the classic method that will help in lowering the rate of funding sources. Bonds will be inclined to mature after a period that will match up to the NBFCs’ interest payment schedules.

Issuance of commercial papers can be availed for short-term loans

For the NBFC funding, the NBFCs can issue commercial papers to increase their capital. Those NBFC, whose net worth is 100 cores, is eligible to issue commercial papers as per the R.B.I.

Securitization of loans

The NBFC funding method retail sector with the calculative asset under management (AUM) of 14 Lakh Crore approximately is assured for prolonged growth in FY2024. It has been anticipated that an expansion of 18-20% surpasses the earlier estimation of 12-14%. This sudden increase is primarily attributed to revamping the performance of the unsecured loan segment, enterprise loans, and microfinance loans.

Effectiveness and measures taken for the NBFC funding method

These are the following essential conditions for the NBFC funding taken into consideration while raising funds for the NBFCs-:

  1. Examining the asses to liability mismatch
  2. Bringing the mismatch down to a minimum

In this situation, it has to be noted that the assets are described as investments made through the way of equity or debt or structured products in the performance of an NBFC funding method like financing equity, while the liabilities will be referred to as the amount owed to the parties that have supplied the funds for the financing activity. The interest rate imposed between both will amount to an arbitrage that results in a Net Interest Margin. The arbitrage is created as to the value obtained from the capability and experience of the officials in the NBFC to find out the correct segment for investing at a very high risk-reward ratio and give extraordinary returns in the Indian or corporate arena.

Rupee and Treasury Resource Departments

The way to increase the supply of money is generally handled through the hands of the rupee sources department, which involves long and short-term instruments used by the NBFC to balance supply and demand. The Treasury Department is liable for the disposal of any asset variation and money market instruments to be found out when the funds are packed after the resources have been increased, and the funds have been received by the firm.

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Liability/Asset matching in NBFC funds (Indicators)

Rupee and Treasury resources departments depend on the upcoming critical risk variables for the same purpose:

Interest Rate Risk

Interest rate risk arises while raising funds, which has a negative impression on the Net Interest Margin and wears down the value of the NBFC funds’ net worth.

Liquidity Risk

There is always a risk involved in an investment that is unable to be easily marketed or sold to a 3rd party to minimize the losses.

Foreign Exchange Risk

There is a risk of losses occurring as the result of adverse exchange rate fluctuations, like the demonetization that was announced in 2916, particularly when holding an open position, whether spot, combination, or forward.

Equity Price Risk

About the equity investments made by NBFC funds, there is always a risk of a loss on account of public or private equity shares that are held in the portfolio for the equity investments made by NBFC. NBFC funding method usually controls and administers its treasury activities based on the various risks involved in place of the particular type of financial instrument dealt with. It. Giant I.T. systems are put in place to figure out these risks along with the value of one’s risk, and a suitable substitution is required in the investment whenever it is needed. Various times, when there is a chance of default and loss given that default is estimated, that varies with the change in the profile of the particular company that has invested.

Asset liability committees in the Non-Banking Financial Companies (NBFC)  

The ALCO’s primary role is to manage the organization’s liquidity and interest rate risk. These committees are generally looked up by the company’s CXOs to keep their sight on the cost management that might spiral out of control and impact the profitability, especially in a down market.

 Duty of ALCO:

  1. Balance sheet planning for the worthy risk returns and the management of the interest rate and liquidity risk.
  2. Call on the preferred maturity profile and mix of assets and liabilities that can be added up in the future.
  3. Coming up with a viewpoint on the interest rates and also for the future business strategy to contain interest rate risk.
  4. Scrutinizing the funding policy to reduce the liquidity rate.
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Treasury and Liquidation Operation

  1. Treasury operations are diversified into the front, the mid, and the back office. The treasury front office within the institution is the clearance house for matching, running, and controlling material risks. It also bifurcates the investment support for the assets and liabilities given by the regular business of an NBFC. All the dealers eagerly involved in the day-to-day trading activities have to abide by the FEDIA, FIMMDA, and other regulatory codes of conduct. The dealers must also abide by and hold on to the internal stop loss limit.
  2. The back-office sources should have complied with the transactions undertaken. Moreover, prompt settlement of all dealing accounts is an important key to ensuring the exact identification of risk exposures.
  3.  The mid-office has the responsibility of the on-site tracking department and giving value-added support to the front office activities. It acts as an independent risk monetary functionary.
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Relevance of NBFC funding method

The availability of adequate funding sources is essential for the sustainable growth and stability of NBFCs. That’s the reason why the funding became of paramount importance:

Risk Management of the NBFC funding method

A well-arranged funding structure helps the NBFCs to manage the liquidity and the credit risk effectively. That depends solely on one source of funding ready to expose them to the potential disruptions if the dynamics of the market change.

Expanding the businesses

Funding is enabling the NBFCs to expand their operations and management. This would probably lead to the launching of new financial products, the opening of new branches in the secluded areas, or helping specific customers.

Technology and innovative adoption

Innovation will always help in bringing competitiveness to the financial market. Funding permits the NBFC to invest in the technological infrastructure, enabling them to offer safe and secure services to the customers.

Customer Satisfaction

To create a balanced funding base that will always enhance customer satisfaction. It ensures that NBFCs can fulfil their financial demands and provide safe and secure services to customers.

Regulatory Compliance

NBFCs must act in compliance with the regulatory requirements decided by the R.B.I. as the apex body. It should also maintain the appropriation of capital, and liquidity is critical to match up with these requirements to ensure financial stability in the market.

Challenges to the NBFC funding method

As funding became essential for the NBFC to grow, it came up with various challenges to face in the financial arena:

Regulatory Limitations

NBFCs operate in a restrictive, regulative environment. Regulatory guidelines of the R.B.I. restrict certain funding resources to limit inter-corporate deposits and foreign borrowings.

Dependency on Credit Rating

The credit ratings assigned to the NBFCs influence their credibility to raise their funds at favourable terms. Also, to maintain a strong credit rating in the financial market.

Risk in Liquidity

The NBFC should properly manage its liquidity to meet the demands of the customer for short-term obligations. If there is a sudden withdrawal of deposits or disturbance in the fund market, it can also lead to a liquidity crunch.

Volatile tendency of the market

Financial markets are very volatile. They can also affect the cost and availability of funds for the NBFCs. Economic ups and downs in the interest rate can affect investors’ share of the NBFC debt securities.

Conclusion

Funding can be considered the lifeline for the NBFC funding in India, which empowers their operation and growth. These intervenors play a very significant role in expanding access to financial services, bearing economic development, and encouraging innovation in the financial market. With the evolution of the financial sector, the credibility of the NBFCs to secure funds from a variety of sources will be significant for their long-term success. Understanding the complications involved in funding and its investors, regulators, and stakeholders can also lead to the continuation of the growth and stability of the NBFCs sector in the global economy boost. Through the diversification of the funding resources and regulatory compliance, the NBFC funding can mitigate the challenges in the dynamic financial market.

FAQ’s

  1. Who is financing the NBFCs?

    Funds for business come from short-term loans, securitization of loans, bonds, and FDIs.

  2. How does the NBFC funding method escalate money?

    They borrow from other financial institutions, accepting deposits through cheques, mostly term deposits.

  3. Does the NBFC funding method borrow from the banks?

    NBFCs can use the help of banks to borrow funds.

  4. Is NBFC purely a non-banking company?

    NBFCs are generally non-banking in nature, but they perform several banking services for the general public.

  5. Who controls the NBFC funding method in India?

    R.B.I. is an apex bank that controls and regulates the NBFC funding method.

  6. How does the NBFC funding method recover loans or debts from the customers?

    When negotiations fail between them, the NBFC can only recover it through legal recourse.

  7. What activities are not granted to the NBFC funding method?

    NBFC cannot accept demand deposits.

  8. Why are the risks attached to the NBFC funding method?

    NBFC sometimes faces challenges in implementing the regulations due to limited compliance of expertise and resources.

  9. What is the origin of the NBFC sector in India?

    It started in India during the 1960s as an alternate option for individuals whose financial needs are not satisfied through banking channels.

  10. Are the NBFC's businesses profitable?

    Yes, they are profitable businesses, as per the recently published Financial Stability Report of the R.B.I.

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