Funding in NBFC

Funding in NBFC: A Detailed Guide

Overview

Non-Banking Financial Companies (NBFC) have a distinct market position, separated from banks. They are unable to rely on current and savings accounts for fundraising, instead requiring alternative funding sources that are higher than deposit interest rates, which range from 4% to 6% for banks. Because of this, NBFCs require alternative approaches for capital generation.

In this guide, we will explore the importance of venture funding and the sources of funding available to NBFCs.

Why is Funding important in NBFCs?

Any NBFC that is registered under the Reserve Bank of India (RBI) needs fundraising. NBFC is a popular sector for investors, especially those willing to use technology and big data to reduce business risks to 5%. Venture capitalists usually fund startups at the seed, initial, and later stages, and the funding plan depends on the current market scenario and founders' business growth expectations.

The Role of Funding in NBFC Business

Funding and fundraising are the primary resources supporting modern NBFC startups' growth. To achieve these goals, startups must allocate funding appropriately. There is no end to the fundraising process for a startup. It is essential to carry out fundraising on a regular basis, and the funding agenda must be carried out by the founder.

Sources of Funding in an NBFC:

Bank finance to NBFCs Banks can provide working capital and term loans to all NBFCs registered with the RBI. Between September 2018 and February 2019, banks invested Rs 1.9 lakh crore in the non-bank sector, increasing their portfolios by over 40%.
Funding in NBFC from Private Equity and Venture Capital Private equity and venture capital firms are still keen on NBFCs. Investors have now focused on non-banking financial companies (NBFCs) and small finance banks for capital investments as banks are burdened by large non-performing assets (NPA). NBFCs' investments affirm India’s expanding financial services potential.

Sources of Business Funding in an NBFC:

Long-term loans at low-interest rates. An NBFC may request a long-term loan from a bank to finance its activities.
Foreign Direct Investment (FDI) Foreign investment is an excellent funding option available to NBFCs. Foreign investors do not require RBI or FIPB clearance to participate directly in an NBFC.
Issuing Commercial Paper Issuing Commercial Paper helps NBFCs raise capital quickly. It is a short-term unsecured promissory note that has a duration of three to twelve months.
Issuing Bonds Issuing Bonds helps NBFCs obtain significant funds at minimal cost.
Loan Securitization Securitization is a popular strategy used by HFCs and NBFCs to manage liquidity, generate capital, and rectify ALM mismatches.

Measuring the Effectiveness of Fundraising:

NBFCs manage and regulate their treasury operations depending on the several risks they face. Liquidity risk, interest rate risk, foreign exchange risk, and equity price risk are the primary risk variables that the rupee resource department and the treasury depend on to manage specific risks. VaR techniques are used to assess the risk of default, and the investment is trimmed appropriately as needed.

Asset/Liability Matching in an NBFC:

An NBFC's asset-to-liability mismatch must be investigated, and it should be brought down to a minimum to manage risk variables. The treasury mid-office may compute simple maturity gaps, re-pricing gaps, and duration gaps as a starting point, taking into account the size of the data. Given an NBFC's diverse loan product offerings, it would be prudent to measure an IRR on the banking book that considers the impact of rate fluctuations on both earnings and economic value.

Title: Understanding Asset Liability Committees and Treasury Operations in NBFCs

Asset Liability Committees (ALCOs) and treasury operations are crucial for managing liquidity, interest rate risk, and profitability in Non-Bank Financial Companies (NBFCs). This article aims to provide clarity on the role of ALCOs and the divisions within treasury operations, providing insights into their importance in the NBFC sector.

ALCO Role and Responsibilities

ALCOs, led by the company's CXOs, focus on managing the organization's liquidity and interest rate risk. Their key responsibilities include:

Risk-return planning on the balance sheet, including managing interest rate and liquidity risk.
Estimating base rates and product pricing for loans and advances.
Determining desired maturity profiles and asset-liability combinations for future investments.
Developing an interest rate stance and implementing an interest rate risk management plan.
Reviewing funding approaches to mitigate the risk of cash shortages.

Treasury Operations Divisions

Treasury operations are divided into three categories: front office, middle office, and back office. Each division fulfills specific functions:

Front Office: This division acts as a clearing house for matching, managing, and regulating market risks. It also provides investment support for the assets and liabilities generated by the NBFC's regular operations. Dealers actively involved in day-to-day trading operations must adhere to regulatory codes of conduct, such as FEDAI and FIMMDA, and maintain the Internal Stop Loss Limit.
Middle Office: The middle office plays a critical role in on-site tracking and providing value-added assistance to front-office operations. It serves as a self-contained risk monitoring system.
Back Office: The back office ensures accurate and timely completion of all transactions and settlements. It focuses on maintaining control and guaranteeing accurate identification of risk exposure.

Importance of Foreign Funding for NBFC Startups

NBFC startups often seek foreign funding due to the following reasons:

100% foreign funding is allowed without any restrictions in all types of NBFCs, except for deposit-taking NBFCs. This makes foreign funding an attractive option for startups.

Conclusion

NBFCs have a vital role to play in India's expanding financial services ecosystem. Venture funding is critical in the NBFC business. This guide provides details on the sources of funding available to NBFCs and helps measure the effectiveness of fundraising while managing asset/liability risk variables. Both founders looking for venture funding and investors looking to invest in NBFCs will benefit from this comprehensive guide.

Understanding the roles of ALCOs and divisions within treasury operations is crucial for effective management of liquidity, interest rate risk, and profitability in NBFCs. ALCOs play a vital role in risk-return planning, while treasury operations ensure the proper functioning and control of front, middle, and back-office activities. Additionally, foreign funding offers significant opportunities for NBFC startups to raise capital and fuel their growth.

How Estabizz Fintech can help

Estabizz Fintech can help in funding NBFCs by providing comprehensive support in various areas related to NBFC operations and funding. They offer services such as NBFC registration support, assistance in preparing a strong business plan for NBFCs, and expertise in NBFC audits.

Additionally, Estabizz Fintech can help NBFCs in streamlining their operations and adopting innovative financial technology solutions. By partnering with fintech companies, NBFCs can introduce new product offerings leveraging tools that provide access to previously unavailable data and real-time underwriting models.

Process for NBFC Funding

We check the details before processing with any of the entity

When funding NBFCs, several factors are typically considered. These factors may include:

Business Mix and Growth Trend: Lenders assess the types of loans and segments an NBFC caters to, such as retail loan segments (personal loans, vehicle finance, etc.) and wholesale loan segments (corporate loans, infrastructure loans, etc.).

Asset Size: The asset size of an NBFC is an important consideration. Systemically important NBFCs, with an asset size of ₹500 crore or more, are particularly significant, as their activities can impact the overall financial stability of the economy.

Financial Stability: The financial stability of an NBFC is evaluated through its audited balance sheets, capital adequacy ratios, liquidity positions, and profitability indicators. Even we Prepare FSR Report

Regulatory Compliance: Lenders consider the NBFC's compliance with regulatory requirements, including registration as per the Companies Act, 2013 (in India), and adherence to guidelines issued by the regulatory authority.

Credit Risk Assessment: Lenders assess the credit risk associated with the NBFC, including the quality of its loan portfolio, credit appraisal processes, risk management practices, and provisions for loan losses.

Business Plan and Strategy: The lender may evaluate the NBFC's business plan, growth strategy, market positioning, and competitive advantages as part of the funding decision-making process

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