Northern Arc Capital and India Impact Investors Council (IIC) jointly released their first research report in collaboration with TransUnion CIBIL (as knowledge partner) on the “State of Impact NBFCs”, highlighting the need for building a stronger identity for small and mid-sized NBFCs driving financial inclusion at the base-of the pyramid (BOP). The report focuses on the emerging class of non-MFI NBFCs, especially those that focus on segments such as micro, small and medium enterprise (MSME) loans, auto and vehicle finance, and other BoP credit sectors.
Impact NBFCs play a catalytic role in driving social impact, combined with strong financial returns for their investors. On average, 1 out of 3 customers supported by impact NBFCs is a first to credit customer and more than half of Impact NBFCs’ portfolios fund customers in semi urban and rural areas showing their strong impact potential to deepen financial inclusion.
Impact NBFCs have shown resilience across business cycles. Despite asset quality being impacted during the pandemic, disbursements and business performance has recovered and overall risk of sectoral defaults remains low. Data on NBFC borrowings shows non-performing asset (NPA) levels remaining moderately low on the loans borrowed by NBFCs for on-lending (4% on number basis and less than 1% on value terms).
Impact NBFCs are driving innovation across the customer journey right from targeting and identification, to acquisition and onboarding, disbursement, servicing and collection. Impact NBFCs deep understanding of the BoP segment and their ability to identify and manage different borrower risk profiles is also reflected in their asset quality being lower than other larger banks and players serving the low-income segment.
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Impact NBFCs ~ NBFCs with a portfolio size of 75% of the portfolio have been included in the research as Impact NBFCs (only NBFCs registered as non-bank lending institutions with the RBI, excluding fintechs).
The report on ‘State of Impact NBFCs 2021’ reveals that:
Less than 10% of Impact NBFCs have been able to achieve credible scale in the past 5 years owing to challenges in raising equity and debt capital. Impact NBFCs will need INR 58,000 crores equity capital and INR 2,32,000 crores in debt-capital in the next 5 years (USD 7.7Bn and USD 30.9Bn respectively) to sustain their growth.
Despite a benign interest rate environment, impact NBFCs have witnessed compression of margins. Interest spreads have shrunk by more than 200 bps in FY 2021. Recent economic shocks on both the asset and liability side, along with the COVID-19 pandemic, have furthered funding challenges for Impact NBFCs. Smaller Impact NBFCs are most heavily impacted as they are reliant primarily on other non-banks for access to debt capital.
Transmission of benefits at small Impact NBFC level seems marginal. Schemes and measures announced by the Government and RBI have helped reduce the negative impact of the pandemic, yet the challenges on the ground continue.
Ashish Mehrotra, MD & CEO, Northern Arc Capital, highlighted that “Impact NBFCs have played an instrumental role in India’s financial inclusion as catalysts in the spread of formalised credit to millions of unbanked and underbanked customers. Despite adverse business cycles, they have stayed resilient and have showcased deep innovation. That said, there are several challenges they face today including negative perception and access to debt. Our report highlights these challenges and suggests ways in which these can be countered, especially debt finance at the right cost, which we believe is the primary challenge for Impact NBFCs across the board.”
Small and medium sized NBFCs have been successfully operating in challenging segments such as microfinance, microenterprise, affordable housing, and vehicle finance, and contribute to the spread of formalised credit. Commenting on the role of Impact NBFCs, Mr. Rajesh Kumar, MD & CEO, TransUnion CIBIL said, “Impact NBFCs are playing a pivotal role by deepening financial inclusion especially across Tier-3 and Tier-4 geographies and also amongst the new-to-credit customer segment. In order to improve India’s private-debt to GDP ratio, it is vital to support Impact NBFCs with a conducive ecosystem along with insightful data framework for astute lending, while helping scale digital transformation”.
The sector needs active support to help continue to grow and support the cause of financial inclusion in the country. Speaking at the release of the report, Ramraj Pai, Chief Executive Officer, IIC, said, “It is important for different stakeholders whether debt capital providers, equity investors, foundations or institutional stakeholders to engage and work collaboratively towards strengthening the financial inclusion eco-system by supporting smaller Impact NBFCs and helping them flourish and scale”.
While larger non-banks with access to better ratings and a diversified lender base are able to mitigate the liquidity and funding gaps, smaller Impact NBFCs get left behind. Surveys conducted with leading Impact NBFCs also underlined the need to strengthen the capital financing eco-system and regulatory environment for smaller NBFCs. The report provides recommendations and potential interventions which can help Impact NBFCs flourish and grow:
Greater availability of bank funding and an active market for debt funding/refinance for Impact NBFCs. An active platform to support debt funding for Impact NBFCs through a variety of forms including refinancing, sponsoring risk capital or guarantees in addition to funding and support for non-bank intermediaries can improve the availability of low-cost funds for Impact NBFCs
Enabling regulatory guidelines as well as reviewing the scope of guarantee programs to include broader sectors served by Impact NBFCs.
Systemic support via dedicated fund-of-funds to help capitalize smaller Impact NBFCs. This provides an excellent opportunity to tap into a high potential asset class and also generate significant social impact
Increase engagement of Foundations with Impact NBFCs where the capital could take the form of convertible grants or performance-linked debt and help facilitate market linkage and incubation/mentorship in local ecosystems.
