It is becoming clear that non-banks are becoming increasingly important for financial intermediation.
~ Woodrow WilsonFor any economy, financial intermediation is important – be it through traditional banking or non-banking avenues – as this is the way savings get converted to lending and surpluses in one part of the economy can be accessed by others who need it.Traditionally, the Indian credit system has largely been in line with the European system wherein a large part of lending has been extended by the banking system. Europe is home to the world’s largest banking system. The total assets of banks in the EU amounted to over 42 trillion pounds. By contrast, Japanese banks’ assets add up to about 8 trillion pounds, while US banks’ assets are about 11 trillion pounds. In India, a bulk of the lending has traditionally come through banks.Contrast the European model with the US one, where large amounts of credit are provided outside of the banking system. Overall, some 80 percent of corporate debt in Europe is in the form of bank lending, with just 20 percent coming from the corporate bond markets which is almost the inverse of the US. Non-bank lending in the United States has seen its share of evolution over the years. The AUM of the largest MF house in the US stands at USD 4.7 trillion and is in fact higher than the size of the balance sheet of their largest bank (USD 3 trillion).
In Europe, we have seen non-banks take prominence post 2008, given that credit refinancing to existent loans will be resurfacing somewhere during the course of 2017. With many of the erstwhile credit sources under duress and European banks under pressure to reduce balance sheet leverage since 2008, we see this gap being filled using other sources of credit – bond markets in particular. European bond issuance has strengthened post 2012 and thus provides a better alternative to bank loans.
The credit off-take in India has been steadily increasing over the past few years, given strong economic growth, rising disposable income, increased consumerism and easy credit access. In light of this, bank credit had registered double digit growth between FY12 – FY16 with FY15 being the only exception as credit grew by 9.0 percent. However, in FY17, we are witnessing this growth dropping to a mere 4.8 percent. As on February 17, as per data shared by the Reserve Bank of India (RBI).
Despite the issues with bank lending, Indian firms and individuals are not being starved for credit. Many have transitioned to exploring non-bank resources such as bonds and non-banking financial companies to fund their funding requirements. This has resulted in the share of bank credit to total credit diminishing year-on-year. The share of bank credit in the total flow of financial resources to the real sector has dipped to 22 percent this year from as much as 45 percent four years ago.
A larger slice of the credit pie (especially better credits) has migrated into the bond markets increasing its market share to 33 percent from 22 percent. As per industry estimates, debt private placement has reached a record high of Rs 7.03 trillion in FY17, accounting for the vast majority (96 percent) of bond issuances, with the balance 4 percent through public issuance, exceeding current bank loan disbursements. According to SEBI data, corporate bond issues surged 20.2 percent during FY17 on a YoY basis to Rs 7.02 lakh crore.
Short-term commercial papers come a close second, followed by a healthy flow of foreign direct investment. Domestic ratings agency, ICRA pegs retail loan disbursements by non-bank lenders to grow by 19-22 percent this fiscal. Moreover, the commercial paper (CP) issuances in Q4 FY2017 rose by 27 percent on a YoY basis and the CP outstanding recorded a 53 percent YoY increase to Rs 3.97 trillion as of end March 2017. A lot of these instruments are subscribed to by non-banks.
The buoyant debt capital market is expected to ensure aggregate corporate credit borrowing continues to grow at 12 percent during FY18, benefitting from finer pricing in the debt capital markets in comparison to banks’ benchmark lending rates.
So what does this mean in the days ahead?
It is becoming clear that non-banks are becoming increasingly important for financial intermediation. The role of NBFCs as effective intermediaries has been well recognized, with the core strengths of NBFCs being strong customer relationships, excellent understanding of regional dynamics, well-developed collection systems and flexible, personalised services. They reach out to areas where they can compete with banks and also to segments which are credit starved and not served by banks. Improving macroeconomic conditions, higher credit penetration, increased consumption and disruptive digital trends will allow NBFCs’ credit to grow at a healthy rate of 12-15 percent over the next five years.
Despite some fears of shadow banking etc. in the other parts of the world, non-bank-lending in India is actually well-regulated and efficient at risk mitigation. There is tremendous scope for non-bank institutions to lend to medium or small sized Indian companies. While there is a threat of increased competition in the retail lending space from banks, the market is evolving rapidly.
I foresee non-banking institutions using this period of growth to lay stronger foundations via building networks, credit risk mitigation processes and harnessing technology (read analytics) to strengthen their capabilities. They do not constitute any direct challenge to Indian banking, but in fact, would be necessary allies in servicing the growing need for credit. As this happens, it seems that India might well move away from the European model and closer to what we see in the US.