Introduction to NBFC Financing
As the name suggests, NBFCs (or Non-Banking Financial Companies) are not banks. CASA deposits or Current Account Savings Accounts are not used to raise funds by NBFCs. CASA deposits only apply to banks. The RBI issues licenses for the banks in order to accept money from the public. The NBFCs don't have these prosperities. This means they need alternative sources of money supply that are higher than deposits made by banks where the interest rates offered range between 4% and 6%.
These financial institutions, unlike bank lack the ability of raising funds. They end up raising money at a higher rate. This causes the barrier rate to their funds to rise correlatively, in order to maintain Net Interest Margin between 1-3%. This forces NBFCs into looking for alternative strategies to distribute funds to achieve a higher return.
Sources of Fundraising for an NBFC
BANK FUNDING TO NBFCs All NBFCs that are registered with RBI can receive term loans and working capital. According to RBI's latest data, between Sep 2018 and 2019 banks funded Rs 1.9 lakh cr for the non-banking sector. This grew their portfolios by almost 40%.
PRIVATE EQUALITY AND VENTURE CAPITAL FUNDING TO NBFC Since banks are struggling with high levels of non-performing assets, investors have begun focusing their attention on alternative banking structures, such as small finance bank, for the deployment of funds. They continue to eat away at the share of the state-run banks. Experts say that the investment is a testament to the growing financial services ecosystem of India.
Sources for Funds in a NBFC
Three key sources of funding are looking to raise funds without deposit:
Long Term: - These loans are acquired by banks in a single tranche, after determining the amount to be stationed during the normal operations of the NBFC. This allows banks to lend at lower rates due to the CASA deposit nature. It also favours NBFCs with a higher risk-return profile. These loans can either be secured by G-secs, which are monitored by the Treasury Department, or they can be unsecured. Repayment can also be in bullets or structured. The repayment schedules should be in line with those of the assets listed on the balance sheet. For large sums to be raised at competitive interest rates, a good credit rating will be required.
Long-Term: - Bonds can be used to reduce the interest rate of the source of funds. The coupon rate is selected to reflect both the NBFCs rating and a better return than G-Secs. Tax-free bonds may also be issued in certain cases for sectors of priority, such as roads and infrastructure. These bonds have maturity profiles that are in line with the interest or repayment schedules for the investments made by NBFCs. Bonds can also be issued to retail clients, which is an important benefit for NBFCs when placing bonds.
Commercial Paper: - A non-banking finance company can issue short term loans by raising money through Commercial Paper. Commercial Papers (CPs) are short-term unsecured promissory note issued by companies. The time period is usually 3-12 months.
Measuring Found Effectiveness
Keep in mind the following when raising money:
The mismatch between assets and liabilities.
Reduce the mismatch.
Assets are the investments in equity, debt or structured products made by an NBFC to finance its operations. Liabilities are the amounts owed to the parties who have provided the money for the financing activity. A difference in interest rates between the two leads to arbitrage and a net interest margin. The arbitrage is created by the ability and experience of officials at the NBFC in identifying the correct segments for investments with a higher reward-risk ratio, and giving extra-ordinary returns within the Indian or corporate context.
Treasury and Rupee Resources Departments
The rupee resources department is responsible for managing the long- and short-term financial instruments that are used by non-banking finance companies to match supply and demand. The Treasury Department is responsible for disposing of the money, as well as any variances in asset-liability and the call or money market instrument to be used when the funds have been parked.
Major performance indicators in examining asset/liability matches in an NBFC
The Treasury and Rupee Resources departments also rely on these vital risk factors.
1. Liquidity risk: An investment may not be easily sold to a third party in order to minimize losses.
2. Interest Rate Risk: The risk of an increase in interest rates while raising money, which affects negatively the Net Interest Margins and reduces the value of net worth.
3. Foreign Exchange Risk (FXR): The risk of incurring losses due to adverse exchange rate movements, such as demonetization in 2016. This is especially true if you have an open position.
4. Equity Price Risk: The NBFC may suffer a loss if it holds public or private equity in its portfolio. NBFCs manage and control their Treasury activities based on the risks they face, rather than the type of financial instruments that are used. These risks are determined by IT systems that also determine the value at risk. The investment is then trimmed if necessary. The estimated default risk and the Loss due to Default are always updated according to the changes in the profile of any company. The Var method is used to assess potential losses that could be sustained by a trading position or a portfolio due to changes in interest rates and market prices over a specified period.
Variations in interest rates on the market have an impact on the financial value of the institution's balance sheet. In order to assess the impact of rate changes on earnings and economic value, an NBFC's banking book would need to be calculated with IRR. Treasury Mid-Office can calculate simple maturities gaps, repricing gap and duration gaps as a measure that is the easiest. Take into account the volume of data.
Asset Liability Committees for NBFCs
ALCO is primarily responsible for managing the interest rate and liquidity risk within an organization. These committees are typically headed by CXOs to monitor costs that could spiral out of control, and negatively impact profitability, particularly in a down market.
The role of the ALCO
Planning your balance sheet to achieve the best risk-return ratio and managing interest rate and liquidity risks.
Pricing of loans and advances and estimations of base rates.
Decide on the preferred maturity profile, and decide on the mix of assets and liability that can be added in future.
Develop a view on interest rates and decide on future business strategies to reduce interest rate risks.
Re-evaluating the funding policy in order to reduce liquidity risks.
Read our Blog:- NBFC Registration in India | NBFC Compliances
Treasury Operations
The Treasury Ops can be divided into the Front Office, the Mid Office and the Back Office. Treasury Front Office is the clearinghouse for matching, managing and controlling market risk. The Treasury Front Office also provides investment support to the assets and liabilities of an NBFC Registration. All dealers actively involved in the day-to-day activities of trading must adhere to FEDAI, FIMMDA, and other regulatory codes. Dealers must also adhere to the Internal Loss Limit.
Back office ensures that all transactions are compliant. The prompt settlement of dealing accounts is also an important control that ensures the precise identification of risks.
Mid office acts as a tracking department on site and provides value-added support for Front office activities. It is an independent monitoring function.
This section of the website is only for informational purposes. This content does not constitute legal advice. The opinions and statements are those of the author and not ASC Group. They have not been evaluated. ASC Group For accuracy, completeness or changes to the law.
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