`Difference between bank and NBFC narrowing' -- Mr. S. Nagarajan, MD, Ashok Leyland Finance

Sanjiv Shankaran

Ashok Leyland Finance (ALF) and Tata Finance hold an interesting place among NBFCs promoted as they are by commercial vehicle manufacturers.

Traditionally, ALF has depended on commercial vehicle financing for a significant proportion of its revenue. However, recently the company initiated steps to broadbase its revenue stream by entering new areas of finance. The ALF managing director, Mr. S. Nagarajan, explained to Business Line the rationale behind the move and the areas of significance for an NBFC.

Excerpts from the interview:

On an NBFC's critical parameters

For competitiveness, there are two components. One is the cost of funds and the other is the ability to manage transactions cost-effectively. Transaction cost includes the associated risk.

In a financial intermediary business, I think efficient fund raising can only be done by entities that have institutional backing, that is, the ability to source deposits from public. Banks are an example. NBFCs cannot match them in fund-raising; in fact, NBFCs will be borrowing from them. And to that extent lending becomes a disadvantage.

Where we can be competitive is the efficient management of transactions. Any company that is able to have an advantage in transactions will offset other disadvantages and in the long-term be competitive.

On the way NBFCs have evolved over the last five years:

The major change is structural, triggered by the Reserve Bank of India. It came in January 1998, when prudential norms were made mandatory. That in a way forced the exit of some small players, and the numbers have come down.

Even among the RBI-registered companies, the numbers may not be very large. The number of players have come down. That has in a way aided the niche players. For instance, it has changed the attitude of the lenders because they are aware of the quality of borrowers. They are willing to take an exposure to a NBFC and the rates have also become competitive. There was a time when even a Commercial Paper (CP) of a finance company could not be easily placed. Today, things have changed and the NBFCs are able to use other instruments.

The other major change is that the volume of business we can do has really expanded because of fewer people. It has helped us pick up good risk from a larger population. Now with the whole market being there, companies are available to pick up good risk. In the last three years, the risk addition has been much better than the past.

The NBFCs will now remain focussed and not look at unrelated business. All this will help in removing some of the negative perceptions that people have had about the NBFCs over the last few years. Any player in the finance business should continue to look at unfolding opportunities. Entering insurance and other areas are natural phenomena, they will help in broadbasing income stream.

On competition with banks:

The difference between a bank and an NBFC has narrowed. Other than deposit taking activity, the assets are largely similar. The NBFCs have an advantage in management of risks and reach, I would say. Apart from this there is always the adaptability to change, where the NBFCs are fast. Newer banks are also quite like that.

In the long-term, the gap between banks and NBFCs will narrow. In which case a different breed of NBFCs will emerge. For instance, a very focussed entity catering to a small area.

For a company to grow there must be avenues; the range of products it can offer must keep increasing. Growth is possible only by giving varied products.

On the importance of size:

The question for the NBFCs, in general, should be how they can raise funds for growth. If I had to choose between balance-sheet size and reach, I would choose reach because that gives NBFC the ability to take good risks rather than being focussed in one place. Reach may help you take good risks, but future growth will be determined by how adequately and viably we can raise funds. That will be true for banks also.

On ALF's strategy:

ALF has been predominantly in commercial vehicle financing. So far commercial financing has been the domain of private sector finance companies. With new players approaching this segment aggressively, retaining our marketshare in the long-term will have to be done by matching the products of the competition. As a consequence, the margins can be under constant pressure.

The other segment we are concentrating on is passenger cars. Here, banks are able to position themselves aggressively in areas where they can reach faster. Metros are almost out of reach for NBFCs.

The other segment we have is multi-utility vehicles (MUVs). It is more or less on the pattern of commercial vehicles vis-a-vis risk. There we certainly have considerable scope. The other segment is construction equipment...will take time for others to get in. Monitoring these risks will have to be localised. It calls for a lot more understanding of customers' cash flows.

Let us categorise the products into two. Cars will be personal products. Commercial vehicles, MUVs and construction equipment, I will call infrastructure products. The latter account for 80 per cent and the former 20 per cent of the revenue. So, our strategy is to widen this and ensure that transportation and infrastructural risk are brought down to two-thirds. And have one-third risk in the personal side.

In the personal side, we are concentrating on expenditure that goes into a household. In three years time... with this we will be able to retain and improve market share in infrastructural section and also give an opportunity for growth in the coming years. This is the strategy on our existing business.

We are also at an advanced stage of developing a loan portal by which we will have the capability to distribute loan products of other intermediaries. The main thing we are looking at is the management of the loan -- the back-office work of processing and collection. We will also throw open our branches to monitor for third parties. In the long-term this will enhance shareholder value.

On the impact of the strategy on ALF's risk:

Contrary to public perception, personal loans have a lower risk attachment. Contrary to perception, this is one area where risk is low and returns are high. If you look at the risk, I would say personal product risk evaluation is more streamlined vis-a-vis commercial vehicles. Cash flow assessment is more accurate in personal products. To make matters better, we will be connected. Customers going to the dealer can obtain the vehicle without running around.

We are also roping in local strength. We are likely to expand our branches. We intend having a service provider who will manage on our behalf. All this will be linked. A franchise system, their job is to monitor, but no risk would be taken by them.

On the pros and cons of being linked to manufacturer of CVs:

The advantages are that the goodwill of the manufacturer automatically flows to the company. The fact that we use the same name has brought in a lot more acceptability. Proving our credibility was not a problem.

The other advantage is the synergy that exists and the fact that we do not finance competitor's vehicles make ALF the first choice of referral for dealers. They have an assurance that a proposal referred here will not be converted into a competitor's vehicle. A perfect synergy of business. That helps us in cornering a larger share of Ashok Leyland vehicles.

Disadvantage is that because of the focus the entire market is not available. We are restricted to just Ashok Leyland's share of the market. Given the restriction NBFCs in general have on capital adequacy ratios, the money available for deployment is going to be limited. It is for the company to see how much is to be distributed in what segment. I may not feel comfortable disbursing everything in commercial vehicles even if the money is available. That way our being a manufacturer promoted company will not impair the overall growth.

On the recent slowdown in the commercial vehicle segment:

Our financial year begins now. Compared to last July, our disbursement has doubled. Normally, when there is a slowdown, the not-so-serious players drop out. We always found that during a slowdown our marketshare improves. One reason will be that, when a slowdown takes place fringe players vacate. In a slowdown, the commercial-vehicles-focussed companies fare better. I feel the slowdown is temporary. It should change with the kind of growth in the economy that is predicted. It should change September onwards.