7 'Non-Bank Financial Companies' (NBFCs) Operating in India



Some of the 'non-bank financial companies' (NBFCs) in india are: 1. Investment Companies, 2. Loan Companies, 3. Hire-Purchase Finance Companies, 4. Chit Funds, 5. Nidhis,  6. Equipment Leasing Finance Companies and 7. Housing Finances Companies.

A wide variety of non-bank companies (NBCs) accept deposits from the public.

The RBI divides them broadly into two categories:

(a) Financial companies and

(b) Non-financial companies.

Only the former (i.e. NBFCs) can be called NBFIs as they raise funds from the public and also lend to it, whereas non-financial companies are basically companies engaged in manufacturing or trade and accept deposits from the public for their own use.

The RBI collects annually data from all companies reporting deposits, whether public limited or private limited, government or non-government. The Latest RBI survey gives data for March 31, 1988 (RBI Bulletin, July 1991).

On this date, there were about 10,300 such reporting companies, of which 7,600 were financial companies and the rest were non-financial companies. The total amount of deposits (mostly in the form of fixed deposits) outstanding was about Rs. 24,000 crore, of which about 70% were with the non-financial NBCs and the rest were with NBFCs. Thus, the average amount of deposits per NBFC was only about Rs. one crore, indicating very small size of such companies.

Collectively, these deposits of NBFCs formed only 6.3% of total deposits with scheduled commercial banks at about Rs. 1, 18,000 crore as on March 31, 1988. This indicates the NBFCs do not pose much competition to commercial banks and do not also pose any serious problem 'for monetary and credit policies of the RBI. However, they do call for much stricter regulation of their activities and proper inspection of their books of account so as to safeguard better deposits of the public and curtail their several alleged malpractices.

Their finance also is highly costly as compared- to bank finance. However, they do serve the needs of the small savers and the borrowers. That is why they are showing a respectable rate of growth of more than 15% per year in their operations.

We discuss below individually several NBFCs operating in India. The data given are all drawn from the RBI Bulletin (July 1991).

1. Investment Companies:

The investment companies are pure financial intermediaries that specialise in the mobilisation of public savings for investment in corporate securities. Unlike commercial banks and insurance companies, they do not render any other service than that of financial intermediation. Their special service comprises entirely of professional management of a large and diversified portfolio of corporate securities. The gain to their investors, therefore, rests purely on the quality of this service.

The invention of the joint stock company paved the way for large scale industrial enterprises in the private sector. Through corporate securities as financial assets long-term savings of the public can be mobilised for financing corporate activities. To the investing public, equity shares offer an opportunity whereby it can participate in the profits of companies without taking part in their management. But investment in corporate securities, especially ordinary shares, is both risky and tricky.

There can be wide fluctuations in stock prices for any number of reasons, converting expected profits into large capital losses. It is neither feasible nor worthwhile for small investors to keep track of the developments likely to affect the prices of stocks they are holding and take corrective action in time. The pooling of risks through portfolio diversification is also not fully open to a small investor on account of the small size of his investment portfolio.

Hence there arose a need for the services of financial intermediaries specialising in investment in corporate securities in a diversified manner and under professional management. The public, then, could entrust their savings to these intermediaries and reap the gains of investment in corporate securities under professional management at a small management fee.

What intermediaries do essentially is to, transmute primary securities buy, which are individually risky, into secondary or into securities of their own which are much less risky. By buying shares of these intermediaries, the investor essentially buys a prorata share in the diversified securities' portfolio of the intermediary.

In response to the above need, two main types of investment companies have grown in the industrially-advanced west. They are (a) closed-end investment companies and (b) open-end investment companies. Following convention, we shall call the former only investment companies.

The latter are called 'unit trusts' in the UK and 'mutual funds' in the USA and Canada. Closed-end investment companies are so called, because at any time such a company has a fixed amount of share capital. That is, its share capital end is closed. On the other hand, an open-end investment company always stands ready to sell and redeem its shares at prices based on the current value of their assets. Its capital end is always kept open.

Investment companies are not important mobilisers of public savings in India. Most of them are very small. At the end of March 1988, there were 4,000 reporting investment companies (of which 800 companies were public limited and the rest were private limited), with Rs. 425 crores of net owned fund and Rs. 730 crores of deposits, borrowings and other receipts. Private limited companies are set up to manage the investment of a few private persons. Public limited companies sell equity and debt to the public in the same way as industrial companies do.

They distribute the income which they earn on their investments by way of dividends. Their securities trade in the stock market in the same way as does other corporate securities. The market prices of their securities may or may not equal the current value of their assets. There are only a few genuine public limited investment companies or trusts with diversified securities' portfolio and they are small.

Most are controlled by large business or industrial groups and their investments are concentrated in the companies of the industrial groups to which they belong. Almost all prominent industrial groups have their own investment companies. The major objective of these companies is to control, manage, and assist companies within their particular groups.

They do not provide the public the advantage of diversified portfolio holding. Hence they have not been able to attract much public savings. In the changed institutional set up with a variety of public financial institutions to meet the credit needs of both large and small companies, there does not seem much of a case or scope for investment companies in India.

2. Loan Companies:

Another type of NBFIs is loan companies (also called finance companies) found all over the country. (In addition, there are a large number of individual and partnership firms that are engaged in loan business, but are not covered by the RBI survey). At the end of March 1988, there were 1550 reporting loan companies (of which 800 companies were public limited), with total liabilities of about Rs. 7,100 crores. About 60% of this amount was raised in the form of borrowings, other receipts and deposits, and the rest represented their net owned funds.

Loan or finance companies are able to attract fixed deposits from the public (especially small savers) mainly by offering high rates of interest, coupled with various kinds of prize, gift, insurance, and other schemes. The services of agents (mostly part-time) are also used to solicit deposits. A part of the funds are kept in fixed deposits with banks and the rest are used to make loans and advances to wholesale traders, retailers, small scale industries, and self-employed persons.

The borrowers are persons who cannot get any or adequate credit from commercial banks. The loans of finance companies are generally unsecured. The effective rate of interest charged on loans is very high anywhere from 36 to 48 per cent per year.

Yet their business is increasing because there are a large number of borrowers with unsatisfied demand for credit who have nowhere else to turn to for credit. The business of finance companies is not regulated by the authorities. The really effective solution lies in banks offering effective competition to these companies in their lending business.

3. Hire-Purchase Finance Companies:

Hire-purchase means purchase on an installment plan. The credit involved in the installment plan is provided by financial institutions. Hire-purchase facilities are needed mostly by small buyers of equipment, whether engaged in farming, fishing, or manufacturing, small transport operators for purchase of vehicles (new or old) and their spare parts, households for purchase of consumer durables, such as bicycles, cars, electric-fans, sewing machines, refrigerators, TV sets, etc.

In all find purchase of durable goods is involved. Small buyers may find it difficult to buy them cash. Durable goods give a flow of income or service over a number of years over which the purchasers may like to make Payment. Therefore, they are encouraged to buy them if installment credit on reasonable terms is available. Under appropriate arrangements, goods themselves can serve as security till the loan has been fully repaid. Invariably, the goods are hypothecated to the lender. For encouraging small entrepreneurs to set up shop and existing small producers (farmers and others) to use modern tools and implements, hire-purchase credit can play an important role.

In India the facilities for the provision of hire-purchase credit are limited and undeveloped. Three major types of financial institutions operate in this field commercial banks, SFCs and the National Small Industries Corporation (NSIC), and hire-purchase finance companies. The bulk of the hire-purchase credit goes to the road transport industry for the purchase of vehicles (new and old) and their spare parts.

At the end of March 1988, there were 630 reporting hire-purchase finance companies with Rs. 1,000 crores of total capital, of which Rs. 200 crores were net owned funds and the rest were fixed deposits, borrowings and other receipts. In addition to companies, there are a large number of individuals and partnership firms operating in the field. Such institutions are better developed and organized in the southern region than in other areas.

Most of them suffer from the problem of shortage of resources. Their organizational structure is weak. Their credit is very costly. Therefore, there is a clear need to institutionalise hire-purchase credit, to encourage the formation of strong and viable units, to introduce compulsory licencing of all hire-purchase finance units, and to regulate their operations, including the rates of interest charged by them. May be the commercial banks should enter the field in a bigger way by organizing a few subsidiary hire-purchase finance companies.

4. Chit Funds:

The chit funds are of many variations. They are essentially savings institutions. The members of a chit fund make regular periodical subscriptions to the fund. The periodic collection is given to some member of the fund, selected in a previously-agreed manner. Each member is assured of his turn before another gets it the second time.

A major part of the total chit fund business is done in Kerala and Tamil Nadu. At the End of March 1988, 1160 chit companies, with deposits and other receipts o Rs. 800 crores, had reported to the RBI. Timberg and Aiyar (1980) estimated an annual turnover of Rs. 250-300 crores of credit through chit funds for late 1970s. The credit involved is totally unregulated.

5. Nidhis:

The nidhis are peculiar to South India, particularly Tamil Nadu; they act as mutual benefit funds and so deal only with their members. They are popular mainly among middle-class families in urban centres. The major source of their funds is deposits from the members. They make advances to their members usually for such purposes as house construction or repairs, etc. The loans are mostly secured. The rates of interest charged are reasonable. Nidhis are highly localised, single office institutions that offer low-cost financial intermediation services to their members. The deposits mobilised by them are not large.

6. Equipment Leasing Finance Companies:

The past few years have witnessed a very rapid growth of such companies. At the end of March 1988, there were only 76 reporting leasing companies with Rs. 666 crore of capital. Most of these companies are small private limited companies. But, in recent years, big business houses have also entered the field and set up their own subsidiary leasing and hire-purchase firms to finance, among other things, the sale of their products and thereby boost their sales.

Perceiving a vast potential for lease business, the commercial banks have been permitted (since August 1984) to invest in the shares of leasing companies or to set up their own subsidiaries for transacting equipment leasing business. The SBI (and also the ICICI) have already set up such subsidiaries.

Leasing is a form of rental system. So, the main function of leasing companies is to lease out equipment on rent to industrial companies. The rental covers accelerated depreciation of machines, interest on initial capital value (computed at higher than its own average borrowing fate) and service charges. Several companies combine lease business with hire-purchase business.

Apart from net owned funds, the leasing companies raise funds in the form of deposits from the public and shareholders and borrowings from other companies, banks and other financial institutions. They are allowed to borrow up to 10 times net owned funds, the gains to the lessee from equipment leasing it arise from invest arrange for capital funds to n equipment and yet carry out its plans for expansion or modernisation. In a tight credit situation, the funds so released can be used profitably elsewhere; and (ii) full tax write-off can be claimed on the high lease rentals paid.

7. Housing Finances Companies:

As the name indicates, such companies provide housing finance. As yet, they have not made much progress in India. At the end of March 1992, there were 18 such reporting companies, with borrowings of Rs. 1,620 crore from the National Housing Bank in the year 1994-95.