Non-banking financial companies consolidate

By Sanjay Asher and Bhumika Batra,Crawford Bayley & Co

The non-banking financial companies (NBFC) sector, which grew rapidly in the early 1990s but later witnessed a turbulent period, has been in a phase of consolidation during the last two years.

Sanjay Asher, Partner, Crawford Bayley & Co
Sanjay Asher
Crawford Bayley & Co

The main reasons for to the accumulation of non-performing assets, innumerable closures and bankruptcies must have been deteriorating credit fundamentals and difficult business conditions, which impacted credit growth in their primary businesses.

Additionally, the flow of retail public deposits declined sharply after the changes in the regulatory environment and increased caution exercised by retail investors. The uncompetitive size, the difficult business outlook on the asset and liability side, declining performance and the inability to recapitalize resulted in a large number of weak companies closing down.

Mergers are a logical route for the consolidation, but most potential buyers have adopted a cautious approach due to apprehension over undisclosed liabilities at the NBFCs. Instead, buying securitized asset portfolios has been the most common method of acquisition – even if some companies have resorted to complete asset buyoffs.

Some of the larger players, including domestic financial institutions, are also buying parts of branch networks of smaller regional NBFCs to increase their reach.

As a result of restructuring in the industry, Indian entities that have survived the stress are realigning their businesses.

In this new scenario, the cost of funds and the ability to capitalize regularly are key factors for NBFCs looking to sustain good asset quality, maintain reasonable returns and defend their market position.

The major change is structural and was triggered by the Reserve Bank of India (RBI) when it made Non-Banking Financial Companies Prudential Norms (Reserve Bank) Directions, 1998, mandatory for all NBFCs – regardless of whether they took deposits.

Management changes

The RBI has prescribed certain norms for cases when there is a proposed change in control or management of a NBFC. The procedure must be followed in cases where there is a sale or transfer by sale of shares, a transfer of control with or without sale of shares, or an amalgamation or merger with another NBFC or non financial company.

Through circular DNBS (PD)/CC NO 11/02.01/99-2000 of 15 November 1999, the RBI stated that public notice of three months must be given before a sale, transfer by sale of shares, or transfer of control with or without a share sale.

The RBI grants a certificate of registration to an NBFC after assessing and evaluating various factors, including the quality of promoters and management, to protect the interest of depositors and the soundness of the financial system.

The aim of the public notice is to ensure that the new management serves these objectives, and to keep the public informed about management and control changes.

This public notice should be given by the NBFC and by the transferor or the transferee. The RBI has also clarified that, for this purpose, the term “control” shall have the same meaning as in Regulation 2(1)(c) of the Securities and Exchange Board of India’s (Substantial Acquisition of Shares and Takeover) Regulations, 1997.

The public notice must indicate the intention to sell or transfer ownership or control, the particulars of the transferee and the reasons for the sale or transfer of ownership or control.

The RBI has also provided certain rights to the depositors of the NBFC’s to protect their interests. Circular DNBS (PD)/CC NO 12/02.01/99-2000 of 13 January 2000 says that NBFCs seeking a change in management, a merger or amalgamation must give depositors an option to decide whether to continue the deposits with the company. The company would be obliged to honour repayment claims and non-compliance could result in penal action.

However, the circular is silent as to how the depositor must be informed. It also fails to state the time limit within which the depositor should decide whether to withdraw its funds.

The RBI’s initiative towards promoting more acquisitions in the sector is undoubtedly commendable but there are loopholes. For example, the Reserve Bank of India Act, 1934, defines the term NBFC but there are other simultaneous definitions.

Still, barring a few anomalies, the difference between a bank and an NBFC has narrowed. Other than the ability to take in deposits, their assets are largely similar. NBFCs have an advantage in management of risks and reach and are more adaptable to change, having the ability to react faster.

In the long-term, the gap between banks and NBFCs will narrow further, likely leading to the emergence of a new breed of NBFC – one that could be a much more focused entity catering to a small area.

Sanjay Asher is a partner and Bhumika Batra is an associate with Crawford Bayley & Co.

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