NBFC Funding in India
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The Non Banking Financial Companies as the name itself makes it clear are not the banking entities. They do not depend on the Current Account Savings Account deposits for raising funds. As Current ASA deposits are only significant for banks, wherein the banks are provided with licenses by the RBI in order to accept monies from the public. NBFCs do not have those prosperities, which means that the NBFCs need alternate sources of the money supply, which are higher than the deposits taken by banks, where the interest rate offered is between 4%-6%.
Unlike banks these financial institutions lack the ability to raise funds, they end up raising funds at a higher interest rate, thereby causing the barrier rate on their funds to increase correlatively in order to sustain Net Interest Margins between 1-3%. This causes the Non Banking Financial Companies to look for substituted strategies for distribution of funds in order to produce a higher return (in order to take on an elevated risk pattern).
Measuring the Effectiveness of Fund Raising
The main points to keep in mind while raising funds are,
- Examining the mismatch between assets & liabilities;
- Reducing the mismatch.
In this case assets are defined as the investments made by way of equity or debt or structured products in the operations of an NBFC as a financing unit, while liabilities are referred to as the amount owed to parties that have supplied the monies for the financing activity. The interest rate levied between the both leads to an arbitrage, thereby resulting in an NIM or the Net Interest Margin. The so created arbitrage is the value derived from the capability and the experience of the officials in the Non Banking Financial Company to identify right segments for investment at a higher risk-reward ratio and give extra-ordinary returns in the Indian or Corporate framework.
Sources of Funds – NBFCs
There are 3 key sources of funds seeking to raise money without deposits:
These are through term loans acquired from banks in a single portion, after finalizing the amount of funds to be stationed in the normal course of operations of the NBFC. The benefit of doing so is that banks can generally lend at much lower rates delinquent to the nature of the CASA deposits, which favors the business model of NBFCs that have a more hostile risk-return profile. These kind of loans can be unsecured or secured through G-secs (monitored by the Treasury Department), and repayment can be done in bullet or a structured schedule. This repayment should preferably be mirrored with the repayment schedules of the assets on the balance-sheet. A good credit rating is compulsory for raising huge sums at a competitive interest rate.
Bonds are used as a general method to diminish the interest rate on the sources of funds. The coupon rate on the bond is chosen in order to reflect the rating profile of the Non Banking Financial Companies as well as a return better than the G-Secs. In some cases, tax-free bonds are also issued for priority sectors such as infrastructure and roads. The maturity profiles of these bonds be in accord with the repayment or interest schedules of the investments made by the Non Banking Financial Companies. Bonds can be issued to retail investors as well, which is a prime benefit for NBFCs during bond placement.
Short term loans offered by a non banking financial company can be issued by raising funds through Commercial Paper. CP’s are short term unsecured promissory notes issued by companies, with a time period of 3 to 12 months.