Covid Learnings for small and medium NBFCs

It is a facile statement to make that the Covid-19 related developments are a black swan event. It has been argued that this is perhaps even worse than the Great Depression of 1929-33 and surely much worse than the 2008 global financial crisis. There is nothing anyone can do about this except to protect oneself and one’s business from the ill-effects of the pandemic. The purpose of this write-up is to list down some of the learnings that could benefit NBFCs – especially the small and medium ones. 

First, the only ally of an NBFC is the fundamental strength of its business. Businesses that are built on solid fundamentals are more likely to survive – strong ALM, focus on portfolio quality, strength of the collection team would be the deciding factors and not the rate of growth of the book or profits. Conservative business practices would be the best weapon to fight external crises such as the pandemic.

Second, NBFC business is not just an asset-side business, but is very much a liabilities-side business. The bigger issue facing NBFCs today is not asset quality but raising liabilities. With increasing risk aversion on the part of the banks to lend to NBFCs and drying up of money markets, managing liabilities has assumed much greater importance. Let us not forget that an NBFC can possibly survive with a sudden burst of NPAs, but even a small cash flow mismatch can lead to default, rating downgrades and death of the NBFC. 

Third, size matters. Even in these times of crises, larger NBFCs have managed to withstand adversities than small entities. Gone are the days when an NBFC could just concentrate on a micro-market and one segment and stay small. Larger the entity, greater is its ability to sustain and grow even in adversity. Perhaps the time has come for NBFC promoters to look at dilution of control and faster growth in the interest of sustainability of business. 

Fourth, there is no substitute to high standards of governance. If we see the recent failures in the banking and NBFC space, the failed entities met their fate not due to scale or size or wrong business model etc., but due to poor governance standards. Yes, high governance standard comes at a price, but it is perhaps better to pay that price than suffer business collapse. 

So what can NBFCs – especially smaller ones do?

First, to put governance standards in place for a much larger scale of business – in terms of getting good external directors on board, getting knowledgeable consultants to reshape business and making compliance with regulations as a top priority. This will surely bring the profit down in the short run, but will boost respectability and therefore business prospects in the longer run.

Second, keep at least 45-60 days of cash flow needs as liquid securities. This should be seen as an insurance policy against defaulting on any liability repayment obligation. Existence of this would also give a lot of comfort to lenders for them to consider any fresh loan application from the NBFC.

Third, be open to merger/consolidation/external equity infusion if that can help in diversification of risk or quicker growth and sustainability of business. It may be worth remembering that 25% of a Rs. 1000 cr business is greater than 100% of a Rs 100 cr business!

Fourth, there is no short-cut to a long, hard route to a successful business. Conservative lending practices, constant effort to get higher credit ratings, strong focus on governance etc. do not come easy, but there is really no choice. Sticking to fundamental principles is easier said than done, but could be the difference between the business that just survives and the business that makes a mark.

The IL&FS and the Covid events have the potential to separate the men from the boys and it’s our choice to belong to either camp.

— Mr. K V Srinivasan, Co-Chairman, Finance Industry Development Council (FIDC) and Executive Director and C E O, Profectus Capital Services Pvt. Ltd.