Non-Banking Financial Institutions (NBFIs) supplement the efforts of scheduled commercial banks in credit delivery and financial intermediation. Given their growing inter-linkages with the banking sector, financial soundness of NBFIs assumes considerable importance to ensure overall financial stability. In 2009-10, the consolidated balance sheet of Non-Banking Financial Companies-Non-Deposit taking-Systematically Important (NBFCs-ND-SI) expanded but their Return on Assets (RoA) declined. In the case of Financial Institutions (FIs), there was an expansion in the combined balance sheet along with an increase in their net profits. However, the RoA of FIs declined marginally during 2009-10. In contrast, there was a steep decline in the profitability of Primary Dealers (PDs) in 2009-10 mainly due to the hardening of government securities yields.

1. Introduction

6.1 Apart from commercial banks and cooperative credit institutions (urban and rural), the financial system in India consists of a wide variety of NBFIs, such as Non-Bank Financial Companies (NBFCs), financial institutions and primary dealers. NBFIs form a diverse group not only in terms of size and nature of incorporation, but also in terms of their functioning. In addition to enhancing competition in the financial system, these institutions play a crucial role in broadening the access of financial services to the population at large. With the growing importance assigned to the objectives of financial penetration and financial inclusion, NBFIs are being regarded as important financial intermediaries particularly for the small scale and retail sectors.

6.2 NBFCs, the largest component of NBFIs, can be distinguished from banks with respect to the degree and nature of regulatory and supervisory controls. First, the regulations governing these institutions are relatively lighter as compared to banks. Secondly, they are not subject to certain regulatory prescriptions applicable to banks. For instance, NBFCs are not subject to Cash Reserve Requirement (CRR) like banks. They are, however, mandated to maintain 15 per cent of their public deposit liabilities in Government and other approved securities as Statutory Liquidity Ratio (SLR). Thirdly, they do not have deposit insurance coverage and refinance facilities from the Reserve Bank. Fourthly, NBFCs do not have cheque issuing facilities and are not part of the payment and settlement system.

6.3 There are two broad categories of NBFCs based on whether they accept public deposits, namely, NBFC-Deposit taking (NBFC-D) and NBFCs-Non Deposit taking (NBFC-ND). Since 2006, NBFCs were reclassified based on whether they were involved in the creation of productive assets. Under the new classification, the NBFCs creating productive assets were divided into three major categories, namely, asset finance companies, loan companies and investment companies. Considering the growing importance of infrastructural finance, a fourth category of NBFCs involved in infrastructural finance was introduced in February 2010 namely infrastructure finance companies (Box VI.1).

6.4 Till recently, NBFCs-ND were subject to minimal regulation as they were non-deposit taking bodies and considered as posing little threat to financial stability. However, recognising the growing importance of this segment and its interlinkages with banks and other financial institutions, capital adequacy and exposure norms have been made applicable to NBFCs- ND that are large and systemically important from April 1, 2007; such entities are referred to as NBFCs-ND-Systemically Important (SI).

Box VI.1: Infrastructure Finance Companies (IFCs) – Need for Separate Classification and Criteria for IFCs

The need for a separate category of NBFCs financing infrastruc Parekh Committee were set up to look into the issue of infrastructure finance. The capability of the NBFCs to contribute sigture sector arose on account of the growing infrastructure needs of the country. Several Committees including the Deepaknificantly towards this growth has been well recognised. In view of the importance of infrastructure financing, it is felt that companies financing this sector should not face the same regulatory or funding constraints as companies financing consumer products or equity investments. Infrastructure financing requires large outlays, long gestation period and large exposures. The commitment required from each lender is high in terms of size of each loan and current prudential norms on credit concentration for NBFCs is likely to act as a constraint on companies participating in infrastructure financing. Hence, a separate class of NBFCs viz., IFCs was introduced with effect from February 12, 2010.

The criteria that would qualify an NBFC as IFC are the following:

1. Companies that deploy a minimum of 75 per cent of total assets in infrastructure loans, as defined in para 2 (viii) of Non-Banking financial (Non-Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007.

2. Net owned funds of `300 crore or above,

3. Minimum credit rating ‘A’ or equivalent; of CRISIL, FITCH, CARE, ICRA or equivalent rating by any other accrediting rating agencies.

4. CRAR of 15 percent (with a minimum Tier I capital of 10 percent).

Infrastructure Finance Companies (IFCs) – Concessions

1. IFCs may exceed the concentration of credit norms as applicable to NBFCs-ND-SI as under:

(i) In lending to

(a) Any single borrower by ten per cent of its owned fund; and

(b) Any single group of borrowers by fifteen per cent of its owned fund

(For other NBFCs-ND-SI, the ceilings are 15 and 25 percent, respectively)

(ii) In lending and investing (loans/investments taken together) by

(a) five percent of its owned fund to a single party; and

(b) ten percent of its owned fund to a single group of parties.

(For other NBFCs-ND-SI, the ceilings are 25 and 40 percent, respectively)

2. ECB can be availed by IFCs through approval route for on-lending to infrastructure sector subject to certain conditions. Five NBFCs-ND-SI have been reclassified as Infrastructure Finance Companies.

6.5 The second major component of NBFIs includes Financial Institutions (FIs). FIs have been broadly categorised based on the major focus of their lending/investment activity, into (i) term-lending institutions such as EXIM Bank, which extend export and overseas investment financing to different sectors of the economy; (ii) refinancing institutions such as NABARD, SIDBI and NHB which extend refinance to banking as well as nonbanking financial intermediaries for on-lending to agriculture, small scale industries (SSIs) and housing sectors and (iii) investment institutions like LIC and GIC which deploy their assets largely in marketable securities.

6.6 Primary Dealers (PDs), the third major component of NBFIs were set up in 1995 with the objective of developing the market for government securities in the country. This was envisaged to be achieved by strengthening the primary market with the creation of a dependable source of demand for these securities as well as by ensuring liquidity in the secondary market.

6.7 This chapter provides analysis of the financial performance and soundness indicators related to each of these segments of NBFIs during 2009-10. The chapter is organised into four sections. Section 2 analyses the financial performance of FIs while Section 3 discusses the financial performance of NBFCs-D and NBFCs- ND-SI. Section 4 provides an analysis of the performance of PDs in the primary and secondary markets, followed by the conclusion in Section 5.

2. Financial Institutions

6.8 As at the end of March 2010, there were five FIs under the regulation of the Reserve Bank viz., EXIM Bank, NABARD, NHB, SIDBI and IIBI. Of these, four FIs (viz., EXIM Bank, NABARD, NHB and SIDBI) are under full- fledged regulation and supervision of the Reserve Bank. IIBI is under the process of voluntary winding up as of March 31, 2010.

6.9 As at end March 2010 EXIM Bank and NHB were fully owned by the Government of India (GoI) and RBI, respectively. RBI which owned a major stake in NABARD diluted its holding in September 2010 from 72.5 per cent to 1.0 per cent resulting in a corresponding increase in GoI ownership from 27.5 per cent to 99.0 cent. The ownership structure of SIDBI as at end-March 2010 indicates that, other institutions held 44.7 per cent of the total equity followed by IDBI, SBI and LIC (Table VI.1).

Operations of Financial Institutions

6.10 Although the financial assistance sanctioned by FIs increased marginally during 2009-10, there was a decline in the disbursements made by these institutions during the year. This was on account of a decline in the disbursements made by investment institutions mainly LIC (Table VI.2 and Appendix Table VI.1).

Assets and Liabilities of Financial Institutions

6.11 The combined balance sheets of FIs expanded during 2009-10. On the liabilities side, deposits along with the bonds and debentures remains the major sources of borrowings (Table VI.3). However, resources raised through borrowings witnessed a decline during 2009-10.

6.12 On the assets side, loans and advances continued to be the single largest component contributing around four-fifth of the total assets of FIs. Similar to the trend observed in the case of Scheduled Commercial Banks (SCBs), the growth of loans and advances from FIs decelerated in 2009-10 as compared to the previous year.

Resources Mobilised by FIs

6.13 FIs raised resources in 2009-10 in both rupee and foreign currency terms. Total resources raised by FIs in 2009-10 posted a
growth of 25.0 per cent, which can mainly be attributed to long-term resources raised by these institutions comprising bonds/debentures (Table VI.4). Among the four FIs, growth in resource mobilisation in 2009-10 was the highest for SIDBI followed by NABARD Bank.

6.14 FIs raise resources from the money market through various instruments, such as Commercial Paper (CP), Certificate of Deposits (CD) and term deposits. In 2009-10, there was a significant increase in the resources raised by FIs through CP (Table VI.5). As a result, CP emerged as the single most important channel accounting for around 80 per cent of the total resources mobilised by FIs from the money market in 2009-10. FIs are mandated to raise resources from the money market within the sanctioned umbrella limit. Given the increase in the amount of resources raised through CP, in 2009-10, FIs had apparently overshot the umbrella limit as against the trend observed in the previous years. However, this impression was created as CP is a short-term money market instrument and FIs kept resorting frequently to this instrument during the year taking the cumulative amount raised through CP to a higher level. It may be noted that the umbrella limit was not crossed each time this instrument was resorted to by FIs during the year.

Sources and Uses of Funds

6.15 In 2009-10, although resources raised by FIs through internal sources registered a decline, these sources continued to be the single largest source of funds for FIs during the year. This fall in internal sources of funds of FIs was mainly on account of decline in the internal sources of funds of SIDBI and NHB. In the case of SIDBI, higher level of disbursements and arrangements of standby lines of credit for managing day to day liquidity caused a reduction in the average investment in short term instruments resulting in decline in internal sources of funds in 2009-10. In case of NHB the internal sources of funds declined as consequence of lower amounts of repayments received from Primary Lending Institutions (PLIs). The funds raised through external sources increased significantly during the year mainly due to a recovery in the global financial markets. Given this increase, the share of external sources increased to around two fifth of the total resources raised in 2009-10 as compared to about one-third in the previous year.

6.16 More than half of the funds raised during the year were used for fresh deployments by FIs. However, there was a significant growth in the funds used for repayment of past borrowings by FIs during the year (Table VI.6).

Maturity and Cost of Borrowings and Lending

6.17 The weighted average cost of rupee resources declined for each of the four FIs in 2009-10 (Table VI.7). Further, the weighted
average maturity of rupee resources also declined for all FIs except NHB during the year.

6.18 NHB and SIDBI lowered their Prime Lending Rates in 2009-10, while EXIM Bank kept it unchanged (Table VI.8). Notwithstanding the fact that prime lending rates were lower or remained unchanged, the growth in loans and advances from FIs worked out to be lower in 2009-10 as compared to the previous year, as alluded earlier (refer Table VI.3).

Financial performance of FIs

6.19 The financial performance of the FIs sector improved during 2009-10 as compared with 2008-09. The net profits of FIs registered an increase mainly on account of the substantial increase in interest income, notwithstanding the decline in non-interest income. However, their net profit as a ratio to total average assets (Return on Assets) declined marginally during the same period (Table VI.9). Among the four FIs, RoA continued to be the highest for SIDBI followed by NABARD. It was the lowest for EXIM Bank (Table VI.10).

Soundness Indicators: Asset Quality

6.20 At the aggregate level, there was an increase in the amount of net NPAs for FIs in 2009-10 as compared to the previous year. The increase in net NPAs, however, was attributable only to SIDBI while in the case of all other FIs, there was in fact a fall in the amount of net NPAs in 2009-10 (Table VI.11 and Chart 1).

6.21 If the four FIs were ranked in an ascending order of the amount of their net NPAs at end March 2010, EXIM Bank appeared at the top having the largest quantum of net NPAs, while NHB was at the bottom with no NPAs. Moreover, the NPA ratio (NPAs as per cent of net loans) was the highest for EXIM Bank. Net NPA ratio of EXIM Bank, however, posted a decline in 2010. On the contrary, the net NPA level for SIDBI increased to 0.19 during 2009- 10 from 0.08 per cent in 2008-09 (Chart VI.1). The increase in the net NPA level for SIDBI was mainly on account of the adverse impact of economic downturn witnessed during the period.

6.22 Notwithstanding the increase in the amount of net NPAs, there were signs of improvement in NPA composition of FIs. This was evident from an increase in the percentage of sub-standard assets in the NPA portfolio of all FIs taken together while the percentage of doubtful assets showed a commensurate decline in 2009-10 as compared to the previous year (Table VI.12). Even in the case of SIDBI, the FI having the largest increase in net NPAs in 2009- 10, there was an increase in the percentage of sub-standard assets and a decline in the percentage of doubtful assets signifying an improved NPA composition.

Capital Adequacy

6.23 The capital adequacy measured by CRAR increased for all FIs except SIDBI in 2009-10. It may be noted, however, that the CRAR was way above stipulated minimum norm of 9 per cent for each of the FIs. CRAR was particularly high for NABARD, wherein capital was almost half of the total risk weighted assets of NABARD indicating that there was considerable scope for this institution to utilise its capital for further credit expansion (Table VI.13).

3. Non-Banking Financial Companies

6.24 The ownership pattern of NBFCs-ND-SI as well as deposit taking NBFCs companies suggest that these companies were perdominantly non-government companies (mainly Public Ltd. Companies in nature). The percentage of non-government companies was 96.6 per cent and 97.1 per cent respectively, in NBFCs-ND-SI and deposit taking NBFCs as against government companies having a share of only 3.4 per cent and 2.9 per cent respecitvely, at end-March 2010 (Table VI.14).

Profile of NBFCs

6.25 The total number of NBFCs registered with the Reserve Bank declined to 12,630 as at end-June 2010 from 12,740 at end-June 2009 (Chart VI.2). There was also a decline in the number of deposit taking NBFCs (NBFCs-D) in 2009-10. This decline was mainly on account of cancellation of Certification of Registration of NBFCs, exit of NBFCs from deposit taking activities and conversion of deposit taking companies into non-deposit taking companies.

6.26 Despite the decline in the number of NBFCs, their total assets as well as net owned funds registered an increase during 2009-10, while deposits recorded a decline. The share of Residuary Non-Banking Companies (RNBCs) in total assets as well public deposits of NBFCs witnessed a decline in 2009-10, while share of the RNBCs in net owned funds registered an increase (Table VI.15).

6.27 The ratio of deposits of NBFCs to aggregate deposits of Scheduled Commercial Banks (SCBs) in 2009-10 indicated a decline. The ratio of deposits of NBFCs to the broad liquidity aggregate of L3 also declined over this year (Chart VI.3).

Operations of NBFCs-D (excluding RNBCs)

6.28 The balance sheet size of NBFCs-D expanded at the rate of 21.5 per cent in 2009- 10 as compared with 3.4 per cent in the previous year, largly due to increase in borrowings of NBFCs-D (Table VI.16). It may be noted that borrowings constituted around
three-fourth of the total liabilities of NBFCs-D. Further, growth of deposits of NBFCs-D sector showed a substantial increase in 2009-10 compared to a decline in the previous year due to increase in public deposits of three NBFCs- D. On the assets side, hire purchase assets remained the most important asset category for NBFCs-D constituting over two-fifth of their total assets. Loans and advances constitute the second-most important asset category which witnessed large expansion during 2009-10. Total investments of NBFCs-D also recorded a sharp rise during 2009-10 primarily on account of rise in non-SLR investments.

6.29 Asset Finance Companies (AFCs) held the largest share followed by loan companies in the total assets of NBFCs-D at end-March 2010 (Table VI.17).

Size-wise Classification of Deposits of NBFCs-D

6.30 A steep increase was discernible in 2009- 10 in the share of NBFCs-D located at the upper end having deposit size of more than `50 crore, accounting for 86.7 per cent of the total deposits at end-March 2010. However, there were only eight NBFCs-D belonging to this class constituting about 3.5 per cent of the total number of NBFCs-D. Thus, only relatively bigger NBFCs-D were able to raise resources through deposits (Chart VI.4 and Table VI.18).

Region-wise Composition of Deposits held by NBFCs

6.31 There was a concentration of NBFCs-D in the northern region of the country, which accounted for 63.5 per cent of companies in the total number of NBFCs-D at end-March 2010. However, the deposit size of NBFCs-D in the northern region was fairly smaller in comparison with the NBFCs-D located in the southern region, which accounted for 67.5 per cent of deposits at end-March 2010. There was, however, a decline in the share of deposits held by NBFCs-D in the southern region in 2009-10 (Table VI.19 and Chart VI.5).

6.32 Among the metropolitan cities, New Delhi from the northern region accounted for the largest number of NBFCs-D, while Chennai from the southern region held the largest share in total deposits of NBFCs-D.

Interest Rate on Public Deposits with NBFCs

6.33 The largest amount of public deposits of NBFCs-D were raised at interest rates in the range of up to 10 per cent with the share accounting more than half as at end-March 2010 (Table VI. 20 and Chart VI.6).

Maturity Profile of Public Deposits

6.34 The largest proportion of public deposits raised by NBFCs-D belonged to the short- to medium-term end of the maturity spectrum. At end-March 2010, the largest percentage of deposits had a maturity of less than one year closely followed by deposits having a maturity of more than two years and up to three years. In 2009-10, there was an increase in the shares of deposits belonging to these two maturity categories, while the shares of deposits belonging to the long-term maturity categoriesof more than 5 years showed a decline (Table VI.21 and Chart VI.7).

6.35 Banks and financial institutions were the dominant source of borrowings for NBFCs-D with a share of over 45 per cent at end-March 2010. The share of borrowings from the Government (extended only to Government Companies) witnessed a steep rise, while there was a noticeable decline in the share of external sources. Others (which include, inter alia, money borrowed from other companies, commercial paper, borrowings from mutual funds and any other type of funds, which were not treated as public deposits) registered a significant growth in 2009-10 resulting in a rise in its share in total borrowings of NBFCs-D (Table VI.22).

Assets of NBFCs

6.36 The total assets of deposit-taking NBFCs- D sector registered a significant growth during 2009-10 mainly on account of increase in the assets of asset finance companies (Table VI.23). As at end-March 2010, around three-fourths of the total assets of the NBFCs-D sector were held by assets finance companies. Components-wise, advances accounted for the predominant share of total assets followed by investment.

Distribution of NBFCs-D According to Asset Size

6.37 Based on their deposit taking capacity only bigger NBFCs-D had larger asset base. At end-March 2010, only 7 per cent of NBFCs-D had an asset size of more than `500 crore, which had share of 97.5 per cent in total assets of all NBFCs-D (Table VI.24).

Distribution of Assets of NBFCs – Type of Activity

6.38 During 2009-10, assets held in the form of loans and inter corporate deposits and investments of NBFCs-D witnessed a robust growth. Notwithstanding a decline in the share of assets held by hire purchase companies in 2009-10, this activity continued to have the largest share in total assets of the NBFCs-D sector (Table VI.25).

Financial Performance of NBFCs-D

6.39 The financial performance of NBFCs-D witnessed moderate deterioration as reflected in the decline in their operating profits during 2009-10. This decline was mainly on account of a higher growth in expenditure (especially financial expenditure) than income of these institutions. The decline in operating profit along with a marginal increase in tax provision resulted in a decline in net profits in 2009-10 (Table VI.26).

6.40 Expenditure as a percentage to average total assets witnessed a significant increase during 2009-10, while income as a percentage to average total assets increased at a slower pace resulting in a decline in net profit to total average assets (Return on Assets) ratio of NBFCs-D (Chart VI.8).

Soundness Indicators: Asset Quality of NBFCs-D

6.41 There was a decline in the gross NPAs to credit exposure ratio of NBFCs-D in 2009-10 in continuation with the trend observed in the recent past. Net NPAs remained negative with provisions exceeding NPAs for three consecutive years extending upto end-March 2010 (Table VI.27).

6.42 There was an improvement in the asset quality of asset finance and loan companies in 2009-10 as evident from a decline in the gross NPAs to gross advances ratio for these companies (Table VI.28).

6.43 There was a decline in the shares of all three NPA categories of sub-standard, doubtful and loss assets of asset finance companies in 2009-10 underlining the improvement in asset quality of these institutions. However, in case of loan companies, there was improvement in share of standard assets at end-March 2010 to 97.3 per cent notwithstanding a marginal increase in share of loss assets (Table VI.29).

Capital Adequacy Ratio

6.44 At end-March 2010, 212 out of 216 NBFCs had CRAR of more than 12 per cent or more as against 221 out of 225 NBFCs at end- March 2009 (Table VI.30). It may be highlighted that the NBFC sector is witnessing a consolidation process in the last few years, wherein the weaker NBFCs are gradually exiting, paving the way for a stronger NBFC sector.

6.45 The ratio of public deposits to Net Owned Funds (NOF) for all categories of NBFCs taken together remained unchanged at 0.2 per cent at end-March 2010 (Table VI.31).

6.46 There was an increase in NOF and public deposits of NBFCs-D in 2009-10. This increase was mainly concentrated in the NOF size category of ` 500 crore and above (Table VI.32).

Residuary Non-Banking Companies (RNBCs)

6.47 Assets of the RNBCs declined by 23.0 per cent during the year ended March 2010. The assets mainly consists of investments in unencumbered approved securities, bonds/debentures and fixed deposits/ certificates of deposit of SCBs. However, NOF of RNBCs increased by 56.2 per cent in 2009-10 (Table VI.33).

6.48 The decline in the income of RNBCs during 2009-10 was less than the decline in expenditure, as a result of which the operating profits of RNBCs increased during the year. Despite the increase in the provision for taxation, the net profits of RNBCs increased sharply during 2009-10 compared to a decline in the previous year.

Regional Pattern of Deposits of RNBCs

6.49 At end-March 2010, there were two RNBCs, of which, one was located in the eastern region while the other was in the central region. RNBCs are in the process of migrating to other business models and the companies would reduce their deposit liabilities to ‘nil’ by 2015. Public deposits held by the two RNBCs registered a significant decline in 2009-10 mainly on account of a substantial decline in the deposits held by the RNBC located in the central region (Table VI.34).

Investment Pattern of RNBCs

6.50 Following the decline in deposit, there was a decline in the investments of RNBCs in 2009-10. The decline was noticeable in the case of unencumbered approved securities (Table VI.35).

NBFCs-ND-SI

6.51 Information based on the returns received from non-deposit taking systemically important NBFCs (with asset size of `100 crore and above) for the year ended March 2010 showed an increase of 16.7 per cent in their liabilities/assets over the year ended March 2009. Total borrowings (secured and unsecured) by NBFCs-ND-SI increased by 19.6 per cent during the year ended March 2010, constituting around two-thirds of the total liabilities (Table VI.36). Unsecured loans continued to constitute the largest source of funds for NBFCs-ND-SI, followed by secured loans, and reserves and surplus.