Non-banking financial companies (NBFCs) have seen considerable business model shift over last decade because of regulatory environment and market dynamics.

In the early 2000s, the NBFC sector in India was facing following problems:

1. High cost of funds

2. Slow industrial growth

3. Stiff competition with NBFCs as well as with banking sector

4. Small balance sheet size resulting in high cost of fund and low asset profile

5. Non performing assets

Majority of NBFCs were not able to face the pressure created on and were wiped out. However, since FY2001-2002, there has been significant improvement in the business model of existing NBFCs with improvement in overall business environment. NBFCs have been able to expand their resource profile by diversifying the funding avenues. Further a strict control on asset quality and overheads, coupled with use of innovative borrowing tools such as securitization has resulted in improved profitability of NBFCs.

Key Insights about NBFC Sector as of Today *

As per CRISIL's NBFC sector report, Net profitability margin of NBFCs has more than doubled from FY2000-01 to FY2001-02 as growing interest spread is key to profitability.

1. Higher Interest yield than banks
   Further on the whole, NBFCs have higher interest yields than banks. The difference in their interest yield can be attributed to the following reasons: -

   • Some NBFCs have a wide reach and traditional niche strengths. Also they have forged good customer relationships in their respective operating geographies. This has led to higher interest yield incomes as they have been able to command a premium.

   • Vehicle finance NBFCs have shown an increasing trend in the component of used vehicles financing in their portfolio. Which offer a higher internal rate of return than new vehicles.

2. Marginal increase in fee based income aided profitability
   The core fee income of all NBFCs improved marginally in FY2002-03.

3. Strict control on overheads help maintain core profitability
   As per CRISIL study, the NBFCs have managed to control any significant increase in their overheads in spite of the expansion in their business and reach.

4. Enhanced investor base and funding avenues bolster resources profile
   The NBFCs business model has strengthened considerably over the past few years in terms of access to varied funding sources. The growth of mutual fund industry and the emergence of securitization as a borrowing tool have helped to strengthen the NBFC sector.

In the near term, NBFCs will continue to maintain their core profitability at close to their FY2002-03 level. Interest costs have declined in FY2003-04 as well, which will enable them to maintain their interest spreads, since interest yields are not expected to decline significantly in the near term. This coupled with the control on overheads, will enable NBFCs to maintain their core profitability in the near term.

* CRISIL Industry outlook: NBFC sector - Risk perspectives