Unmatchable dynamics of the Non-Banking Financial Industry

 Sri Lanka’s NBFI handles the hard-earned money of more than three million depositors whilst more than four million borrowers have obtained loans from these financial institutions

The Non-Banking Financial Industry (NBFI – finance companies to most) plays a critical role in the economy. It enables high returns on savings and accommodates borderline borrowers who are not welcomed by banks. 

Like banks, it too handles financial intermediation processes that facilitate the flow of funds between savers and borrowers. Unlike banks, they are geared to take high risks in order to accommodate new entrants into the market. Most don’t realise the role they play in the economy and unfortunately are not given due recognition by the system. 

Though dominated by banks over the last few decades, the NBFI has played a major role in filling the gaps created by them in the financial industry. It has been very effectively serving the bankable market segment in the rural and semi-urban areas. Had not been for the NBFI, most of the well-known businesses of the country wouldn’t be in existence today. 

Regional trends 

 However, the popularity of the industry is improving day by day in Sri Lanka, although still unrecognised by the system. As per a research done in 2016, the popularity of the NBFI in our neighbouring country India is catching up rapidly to the banking industry with the engine of growth in India’s financial market being in the hands of NBFI. 

The public also reportedly has a better perception of the non-banking industry than they have of banks. Between 2007 and 2013, the NBFI has granted 58% more loans than the banking sector to the infrastructure industry, which is one of the largest industries in India. The study further says that during the same period, the growth rate of banking and NBFI has influenced the growth rate of Indian GDP to a great extent. The balance sheet and credit growth of NBFI have showed even better statistics than the banking sector during the same period; the ROA of NBFI had also been higher than in the banking sector. The growth comparison of assets had gone up from 10.7% in 2009 to 14.3% in 2014 in the NBFI when compared against the banking industry. Overall, the performance and growth of the NBFC sector had been better than that of the banking sector from 2007 to 2013 in India. This clearly shows the public perception of the industry and how much popularity it has won.

Similarly, as per a research done in Bangladesh in 2013, it was found that Bangladesh NBFIs offered a wide range of products and services to mitigate the financial intermediation gap left by banks, thereby playing an important complementary role to the latter. Due to the variety of demands and financial needs of business enterprises, NBFIs are treated as an important, rapidly-expanding sub-sector of the financial system. Their popularity can be gauged by looking at the growth of the non-banking sector portfolio.

This portfolio, which was at BDT (Bangladesh Takas) 78.84 billion in 2000, has grown to BDT 414.11 billion by the end of 2010. During the same period GDP increased to 5.96% from 3.85%, which clearly indicates the very strong relationship between the growth of the NBFI and the GDP.

The report further highlights that emerging new products such as Leasing, Term Lending, Housing and Real Estate Financing, Merchant Banking, and Factoring have contributed to this element tremendously. Products such as Equity Financing, Venture Capital Financing, Project Financing, Pilgrimage Financing had also been popular among NBFI customers. They had also extended their services to Textiles, Agriculture, Cottage, Chemicals, Trading, Pharmaceuticals, Transport, Food and Beverages, Leather Products, Construction, and Engineering. 

Though the growth of GDP is influenced by the overall performance of the economy, there is a significant relationship between the growth of the NBFI and the GDP. The contribution to the GDP from the industry (NBFI) is about 6% in Bangladesh. Considering these findings, it is obvious that due to its wide range of products, the NBFI of Bangladesh is catching up to the popularity of its Indian counterpart.

Banks usually dominate the financial system in most countries, as the commercial, household and the public sectors rely on them for a wide range of financial needs. However, by providing additional and alternative financial products, NBFIs have also already gained considerable popularity both in developed and developing countries.   

Sri Lankan context 

This trend might catch up soon in Sri Lanka as well. The number of customers already enjoying the benefits of this industry is a good case in point for such a hypothesis. The NBFI caters to the common man, and the average size of a financial facility in the NBFI (which is around Rs. 250,000) is a good example to prove such a philosophy. 

This industry handles the hard-earned money of more than three million depositors whilst more than four million borrowers have obtained loans from these financial institutions, which to date total 47 finance and leasing companies registered under the Central Bank of Sri Lanka (CBSL). These comprise 43 Registered Finance Companies (RFCs) and four Specialised Finance Companies (SLCs). 

The difference between RFCs and SLCs is that RFCs are allowed to accept public funds whereas SLCs are not. SLCs mainly operate on bank borrowings, debentures, commercial paper, promissory notes, and their shareholder funds. RFCs are funded mainly through public deposits which have a stake of around 45% of their funding lines. The second line of funding is through banks, which cover around 32% of their funding requirement.

As of the second quarter of 2017, this 80-year-old industry has had almost Rs. 1 trillion net loans and advances in its portfolio, with an asset base of Rs. 1.3 trillion. A compounding growth of 23.8% was shown from the year 2002 to 2016 in the NBFI’s asset base. Out of the Rs. 1 trillion portfolio, 79% was invested in financial facilities, 10% in investments and the balance 11% in other investments such as land and buildings. By the year 2017, the NBFI had 35 listed and 17 unlisted Finance and Leasing Companies (though its number has since reduced) in operation and was 1321 branches strong. Of these branches, 429 were located in Western Province, (an area which has a comparatively better GDP) providing services to its population of 5.9 million. The balance 457 branches were dotted in other parts of the country, serving around 15.9 million people.

What influences the NBFI of Sri Lanka?

Three segments influence the consistency of the NBFI, i.e, the regulator’s role, industry practices, and issues of individual companies. 

The first segment is the role of the Central Bank of Sri Lanka (CBSL) as the regulator. I have touched on the CBSL’s role in NBFI and its valued monitoring process on many occasions in this column, though it too has its weaknesses which at times are beyond its control. The second segment is the industry-related issues that are addressed by a well-known dedicated body – the Finance Houses Association of Sri Lanka (FHA).   

Role of the Finance Houses Association of Sri Lanka (FHA)  

The Finance Houses Association of Sri Lanka’ (FHA) is the body that represents the country’s Registered Finance Companies. It was formed in 1958 as the ‘Ceylon Hire Purchase & Finance Association’. It was then was successively renamed the ‘Hire Purchase and Finance Association of Sri Lanka’ (1977) and the ‘Finance Houses Association of Sri Lanka’ (FHA) in 1986. 

There was no controlling mechanism available to discipline the industry until 1979 other than this self-appointed association, nor any dedicated legislation for finance companies other than the Companies Act. The Finance Companies Act 1979 (No. 27 of 1979) brought finance companies under the control of the Central Bank of Sri Lanka (CBSL) with due controls appropriate in that era. Through this Act, it was made mandatory for all finance companies to register under the CBSL. It has subsequently been amended on two occasions, in 1988 and 1991 (Finance Companies Act, No. 78 of 1988 and No. 23 of 1991). Under such circumstances, the founding members of the association went beyond their boundaries to regularise and discipline the industry. One of the main objectives of the association at the time was to introduce ethical practices. Many finance companies opted not to join this association at that time, perhaps because they had ideas other than the betterment of the industry. Today, the FHA serves as the link between the authorities, the non-banking system and the finance community at large. 

In addition to FHA is another association by the name of the ‘Leasing House Association of Sri Lanka’ (LASL). The membership of LASL is open to any Leasing Company or Financial Institution registered with the Central Bank of Sri Lanka. As most of finance companies in Sri Lanka deal in leasing, there is an overlap in membership between the FHA and LASL.

The third segment is issues pertaining to individual companies. The most likely reasons for finance companies going bankrupt are infected loan portfolios and poor credit management methods, ineffective internal controls and unethical accounting practices, lack of quality human resources, fraudulent activities and illegal deposit-accepting practices, related party transactions and investments in subsidiaries, and over-valuation of assets for window-dressing of accounts.  

Conclusion

In some countries, activities related to the NBFI are known as ‘shadow banking’ which indicates it has less importance in comparison with the banking industry. However, my understanding is that, as the banking industry and the non-banking industry have their own individualisms, exceptionalities, and characteristics, this would be like comparing apples and oranges. NBFI may one day overtake the banking industry in the region as unlike the latter, the NBFI operates on emotional intelligence. Furthermore, though the emerging trend of 4IR which comprises Artificial Intelligence (AI) puts the banking industry at risk, the non-banking industry which basically operates on human intervention might not be at the same risk due to its dynamics.      

[The writer is the founder of Infornets, a non-profit oriented organisation formed to share credit related information and financial knowledge locally and internationally. He counts 36 years of experience in the Non-Banking Financial Industry of Sri Lanka and is a former CEO/ General Manager of a Non-Banking Financial Institution. A member of the National Science and Technology Commission (NASTEC), he also holds a Master’s Degree in Business Administration from the UK and is a member of the Institute of Management of Sri Lanka. He can be reached via [email protected] or www.infornets.com.]