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FINANCIAL PERFORMANCE OF NON BANKING FINANCE COMPANIES IN INDIA Amita S. Kantawala (Reader in Management Studies, M.S. Patel Institute of Management Studies, M.S. University of Baroda, Baroda) Introduction The financial system comprises of financial institutions, financial instruments and financial markets that provide an effective payment and credit system and thereby facilitate channelising of funds from savers to the investors of the economy. In India considerable growth has taken place in the Non-banking financial sector in last two decades. Over a period of time they are successful in rendering a wide range of services. Initially intended to cater to the needs of savers and investors, NBFCs later on developed into institutions that can provide services similar to banks. In India several factors have contributed to the growth of NBFCs. They provide tailor made services to their clients. Comprehensive regulation of the banking system and absence or relatively lower degree of regulation over NBFCs have been some of the main reasons for the growth momentum of the latter. It has been revealed by some research studies that economic development and growth of NBFCs are positively related. In this regard the World Development Report has observed that in the developing counties banks hold a major share of financial assets than they do in the industrially developed countries1. As the demand for financial services grow, countries need to encourage the development NBFCs and securities market in order to broaden the range of services and stimulate competition and efficiency. In India the last decade has witnessed a phenomenal increase in the number of NBFCs. The number of such companies stood at 7063 in 1981, at 15358 in 1985 and it increased to 24009 by 1990 and to 55995 in 1995.2 The main reason for deposits with NBFCs are greater customer orientation and higher rate of interest offered by them as compared to banks. With such a dramatic growth in the numbers of NBFCs it was thought necessary to have a regulatory framework for NBFCs. Slowly the RBI came out with set of guidelines for NBFCs. In one of such step RBI gave definition of NBFCs. According to Reserve Bank (Amendment act, 1997) A Non Banking Finance Company (NBFC) means- i) a financial institution which is a company; ii) a non banking institution which is a company and which has as its principal business the receiving of deposits under any scheme or arrangement or in other manner a lending in any manner; iii) such other non banking institution or class of such institutions as the bank may with the previous approval of the central government specify. The definition excludes financial institutions which carry on agricultural operations as their principle business. NBFCs consists mainly of finance companies which carry on functions like hire purchase finance, housing finance, investment, loan, equipment leasing or mutual benefit financial operations, but do not include insurance companies or stock exchange or stock broking companies.3 To encourage the NBFCs that are run on sound business principles, on July 24, 1996 NBFCs were divided into two classes: i) equipment leasing and hire purchase companies (finance companies) and ii) loan and investment companies. However, the NBFCs segment of finance was less regulated over a period of time. On account of the CRB scam and the inability of some of the NBFCs to meet with the investors demand for return of the deposits the need was felt by the Reserve Bank of India to increase the regulations for the NBFCs. In the light of this background Reserve Bank of India came out with the guidelines on January 2, 1998. The salient features of this guideline are given below. 4 1)

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The acceptance of deposits has been prohibited for the NBFCs having net owned funds less than Rs.25 lakhs. 2) The extent of public deposit raising is linked to credit rating and for equipment leasing and hire purchase companies it can be raised to a higher tune. 3) Interest rate and rate of brokerage is also defined under the new system. 4) Income

recognition norms for equipment leasing and Hire purchase finance companies were liberalized for NPA from overdue for six months to twelve months. 5) Capital adequacy raised 10% by 31/3/98 and 12% by 31/3/99. 6) Grant of loan by NBFCs against the security of its own shares is prohibited. 7) The liquid assets are required to be maintained @ 12.5% and 15% of public deposits from 1/4/98 and 1/4/99 respectively. Modifications also came to these norms over a period of time. The provisioning norms for hire purchase and lease companies were changed. Accordingly, credit was to be given to the underlying assets provided as security. The risk weight for investment in bonds of all PSBs and FD/CD/ bonds of PFI is reduced to 20%5 By monetary and credit policy for 1999-2000 the RBI has raised the minimum net owned funds limit for new NBFCs to Rs. 2 crores which are incorporated on or after 20/4/99. According to the guideline issued on 8/4/99 the company is to be classified as NBFCs if its financial assets account for more than 50% of its total assets i.e. net of intangible assets and the income from financial assets should be more than 50% of the total income.6 By June 1999 RBI had removed the ceiling on bank credit to all registered NBFCs which are engaged in the principle business of equipment leasing, hire purchase, loan and investment activities.7 From above brief summary regarding steps taken by RBI for managing NBFC it is apparent that RBI assigns the priority for proper management of NBFCs keeping in view the investors protection. In the light of the above regulatory frame work one should like to examine various parameters of different groups of NBFCs. Objectives of the Study The classification of NBFCs have been changed over a period of time. The functioning of different categories of NBFCs are not governed by the homogeneous factors. Therefore financial implication can differ for different group of companies. The financial performance of 10 leasing companies has been examined by Seem Saggar 8 at disaggragate level and compared with other groups of NBFCs for a period of 1985-90. Moreover, a study by T.S. Harihar9 throws light on the performance of all NBFCs taken together in terms of cost of debt, operating margin, net profit margin, return on net worth, asset turn over ratio etc. The study by Seema Saggar does not reflect the overall performance of NBFCs as it is based on selected 10 companies. The study by Harihar reveals the aggregate performance of NBFCs which does not throw light on the financial performance of different groups of NBFCs. In the light of these limitations, the present study attempts to examine the financial performance of different groups of NBFCs separaterly. The present study attempts to examine the relative financial performance of different groups of NBFCs for the period 1985-86 to 1994-95 in terms of profitability, leverage and liquidity. The reasons of selecting this period for the purpose of study are: a) During this period the number of NBFCs have flourished by leaps and bounds. b) The absolute amount of deposits with NBFCs have gone up from 4956.6 crores to Rs. 85495.1 crores (increase is almost 17 times). c) The share of deposits with reporting NBFCs have gone up over a period of time from 4.78% to 16.49% (The share is as a percentage of total deposits of Reporting NBFCs Non financial companies and scheduled commercial banks).10 It also attempts to find out the groups for which majority of the ratios are same.

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Table 1. Average Ratios of Various Categories of NBFCS Sr. No. Ratios TS+IH HP LF L 1 Total Income/Total Assets 0.1512 0.1712 0.1107 0.2180 2 GP+D/TI 0.3321 0.3388 0.2366 0.5191 3

GP/TI 0.3105 0.1993 0.2080 0.2267 4 PBT/TI 0.5927 0.1919 0.3031 0.2366 5 PAT/NW 0.1301 0.2137 0.0635 0.1812 6 PAT/TA 0.0701 0.0250 0.0208 0.0457 7 DIV/PAT 0.3009 0.3470 0.7307 0.4120 8 TAX/PBT 0.2358 0.1619 0.4426 0.1117 9 RE/PAT 0.6992 0.6528 0.2681 0.5879 10 Interest Coverage 0.3657 0.7248 0.5889 0.5803 11 BORR/TA 0.3736 0.6157 0.4393 0.5659 12 Bank BORR/TA 0.0763 0.1501 0.1138 0.1608 13 Net Worth/TA 0.5366 0.1283 0.4202 0.2476 14 Bank BORR/Borrowings 0.2039 0.2436 0.2305 0.2887 15 Debt/Total Assets 0.2974 0.4656 0.3254 0.4053 16 Debt/Net Worth 0.5607 4.0566 0.9880 1.7524 17 Debt Equity 1.5064 10.9056 2.3258 4.6714 18 Loan to Current Asset 0.1409 0.8197

0.5984 0.6716 19 CA/CL 14.6767 3.6070 8.6327 3.8816

Data and Methodology For the present study data are collected from various issues of RBI Bulletin11 regarding Financial and Investment companies. As mentioned above, the period covered in the study is ten year from 1985-86 to 1994-95. The categories of NBFCs as per published data are: a) Trading in shares and investment holdings (TS+IH), b) Hire purchase finance (HP), c) loan finance (LF) and d) leasing (L). For the purpose of analysis, for various ratios mentioned below, average of ten years ratio i.e. 1985-86 to 1994-95 is found for each group separately. To examine whether these ratios differ significantly between different categories of NBFCs, One way Analysis of Variance (ANOVA) is applied. (A detailed justification for use of ANOVA for comparing the industry average is available in Reserve Bank of India Occasional Papers, Volume 16, No. 3, September 95, pp. 223-236) In addition of this Krushkal Wallies test is also applied in order to overcome the precondition of normal distribution in case of ANOVA. The selected ratios are divided in to three broad group: viz. profitability ratios, leverage ratios and liquidity ratios. The ratios under study are: Profitability ratios: i) Total income/Total assets; ii) GP+Dep/Total income; iii) GP/Total income; iv) PBT/Total income; v) PAT/Net worth; vi) PAT/Total Assets; vii) Divided/PAT; viii) Tax/PBT; ix) Retained Profit/PAT; x) Interest coverage Leverage Ratio: xi) Borrowing/Total assets; xii) Bank Borrowing/Total assets; xiii) Net worth/Total assets; xiv) Bank borrowing/borrowings; xv) Debt/Total assets; xvi) Debt/Net worth; xvi) Debt equity; xvii) Loan to current assets Liquidity Ratios: xviii) Current ratio Over and above the study of the ratios for all categories of NBFCs one category is also compared against the other one by one. For this purpose also ANOVA is applied. One of the limitations of the study is that the data are taken from the various issues of the RBI Bulletin. The number of the companies falling in each category are different. Moreover the total number of companies taken in the sample also differ from one issue to another. In addition to this even though the number of companies falling in each category may be same but the companies selected in the sample may differ. With this constraints and limitations above stated analysis is carried out.

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Findings i) The average ratios of various categories of NBFCS are presented in Table 1. From the comparative analysis it follows that GP/TI, PBT/TI, PAT/TA and RE/PAT are highest for the Trading in to shares and investment holding companies. Dividend / PAT

and Tax/PAT ratios are highest for Loan finance companies indicating lowest Retained profit to PBT ratio for this group of companies. Interest coverage ratio and PAT/net worth are found to be highest for Hire purchase companies. TI/TA and GP+D/TI is found to be highest for leasing companies. Amongst the leverage ratios Borrowings/Total assets, Debt/Total assets, debt/Net worth, Debt/Equity and Loan to Current Asset are highest for Hire Purchase companies followed by leasing companies on account of higher level of permissible deposit acceptance. Bank borrowing to Total assets and Bank Borrowing to Total borrowing are found highest for leasing companies whereas net worth/total assets is found to be highest for trading in the shares and Investment holding Companies. ii) Table II throws light on whether there is a significant difference in the ratios between various groups of NBFCs or not. The finding based on ANOVA are presented in Table II.
Table II One Way Analysis of Variance Between All Categories of NBFCS Sr. No. Ratios Sum of Square D.O.F Mean Square F-Ratio 1 TI/TA i) Between groups 0.05926 3 0.01975 39.6853 ii) within groups 0.01792 36 0.0005 2 GP+D/TI i) Between groups 0.33796 3 0.11265 12.6749 ii) within groups 0.31996 36 0.00888 3 GP/TI i) Between groups 0.09388 3 0.031292 3.8962 ii) within groups 0.28913 36 0.008031 4 PBT/TI i) Between groups 0.97529 3 0.3251 55.95185 ii) within groups 0.20917 36 0.00581 5 PAT/NW i) Between groups 0.1192 3 0.03973 17.97527 ii) within groups 0.07958 36 0.00221 6 PAT/TA i) Between groups 0.01462 3 0.00487 21.93788 ii) within groups 0.00799 36 0.00022 7

DIV/PAT i) Between groups 1.1307 3 0.3769 1.8249* ii) within groups 7.4352 36 0.2065 8 TAX/PBT i) Between groups 0.63609 3 0.1203 16.3617 ii) within groups 0.46652 36 0.01296 9 RE/PAT i) Between groups 0.10578 3 0.03526 0.43333* ii) within groups 2.92937 36 0.81371 10 INTEREST COVERAGE i) Between groups 0.8956 3 0.2985 35.9109 ii) within groups 0.2993 36 0.0084 11 BORR/TA i) Between groups 0.37888 3 0.12465 13.27491 ii) within groups 0.33797 36 0.00939 12 BANK BORR/TA i) Between groups 0.04414 3 0.01471 4.82775 ii) within groups 0.10971 36 0.00305 13 NET WORTH/TA i) Between groups 0.98784 3 0.32928 27.63877 ii) within groups 0.42889 36 0.01191

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Table III. Krushkal Wallies Test Sl. No. Ratios Compute d Value of ChiSquare 1

Total Income/Total Assets 30.46395 2 G.P.+DEP/Total Assets 23.00497 3 G.P./Total Income 9.7114* 4 PBT/Total Income 27.09958 5 PAT/Net Worth 25.7795 6 PAT/Total Assets 28.06244 7 Dividend/PAT 12.7406* 8 Tax/PBT 23.6810 9 Retained Profit/PAT 9.2284* 10 Interest Coverage 28.499 11 Borrowings/Total Assets 17.9254 12 Bank Borrowings/Total Assets 19.3039 13 Net Worth/Total Assets 26.7453 14 Bank Borrowings/Borrowings 14.7894 15 DEBT/Total Assets 19.9888 16 DEBT/Net Worth 28.3551 17 DEBT/Equity 28.475 18 Loan to Current Assets 33.701 19 Current Ratio 27.8926 * indicates that null hypothesis is accepted. Table II One Way Analysis of Variance Between All Categories of NBFCS (Continued) Sr. No. Ratios Sum of Square D.O.F Mean Square F-Ratio 14 BANK BORROW/BORRWINGS i) Between groups 0.037866 3 0.012562 2.26115* ii) within groups 0.200001 36 0.005556 15 DEBT/TOTAL ASSETS i) Between groups 0.17547 3 0.05849 12.07585 ii) within groups 0.17437 36

0.004844 16 DEBT/NET WORTH i) Between groups 57.04107 3 19.01369 43.61953 ii) within groups 15.69235 36 0.43589 17 DEBT/EQUITY i) Between groups 542.5387 3 180.8462 68.1848 ii) within groups 95.4826 36 2.6523 18 LOAN TO CURRENT ASSETS i) Between groups 2.5699 3 0.8566 216.6275 ii) within groups 0.1424 36 0.0040 19 CA/CL i) Between groups 808.7658 3 269.5886 46.4440 ii) within groups 208.9653 36 5.8046 * indicates that null hypothesis is accepted.

From the table it follows that only for three ratios out of nineteen ratios calculated value of F is less than the table value of F at 5% level of significance. This implies that for these three ratios there is no significant difference in ratios between groups. These three ratios are: a) Dividend/PAT, b) Retained Profit/PAT, c) Ban borrowings/borrowings. For all other ratios it is found that the computed value of F is higher than the table value of F. Hence null hypothesis is rejected. This indicates that the majority of the selected ratios for this study differ significantly between various categories of NBFCs. To overcome the assumption of normal distribution in case of ANOVA, Krushkal Wallies test is also applied. The computed value of Chi Square test is presented in Table III. It is interesting to note that by applying both the techniques only in three ratios out of nineteen ratios null hypothesis is accepted and of these three ratios, two ratios are common in the results of both the techniques. From the above discussion it follows that for different categories of NBFCs there exists significant difference in various profitability ratios, leverage ratios and liquidity ratios. iii) The study is further carried out at the disaggregate level. It tries to find out whether for two different groups the majority of ratios differ significantly or not. This will indicate the relative performance of one group of NBFCs compared to another group of NBFC. Here TS and IH companies are first compared against HP, LF and leasing one by one. Then HP companies are compared against LF and leasing companies and the LF against Leasing companies. The results of ANOVA are presented in TABLE IV.

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Table IV. ANOVA Between two Categories of NBFCs at a Time Sl. No. Ratios TS+IH v/s HP TS+IH v/s LF TS+IH v/s LEASE HP v/s LF HP v/s LEASE LF v/s LEASE 1 TI/TA 3.4380* 13.2570 36.9250 42.2817 32.9715 99.9689 2 GP+D/TI 0.0079* 0.8938* 23.7879 1.2555* 152.9550 26.8212 3 GP/TI 11.5845 3.6047* 4.3430* 0.4618* 7.1022 0.1986* 4 PBT/TI 301.1099 40.1720 192.2260 7.4292 8.4615 2.4690* 5 PAT/NW 34.2829 11.1146 7.5835 79.4161 0.4909* 14.7981 6 PAT/TA 34.6508 31.1358 9.4993 1.5863* 25.1952 17.2020 7 DIV/PAT 2.1763* 2.2559 9.3461 1.8112* 5.9342 1.2442* 8 TAX/PBT 4.9563 10.4775 18.7060 18.0670 2.2929* 26.8250 9 RE/PAT 2.1894* 0.0173* 9.3494 0.1559*

5.8880 0.5749* 10 INTERESTCOV 315.6832 27.7842 83.3465 7.1819 38.2861 0.02636* 11 B/TA 223.6647 1.5431* 34.6453 11.6637 2.5526* 4.6582 12 BB/TA 85.8974 1.2588* 95.1758 1.1532* 1.1516* 1.9109* 13 NW/TA 958.6240 3.8445* 62.8686 25.2377 12.0067 6.5743 14 BB/B 8.9628 0.3743* 21.8771 0.0907* 6.0043 1.6543* 15 DEBT/TA 146.5123 0.7471* 12.6550 19.8551 4.2557* 3.7163* 16 DEBT/NW 429.8119 3.5540* 18.2270 100.4637 37.4496 4.6016 17 DEBT/EQUITY 388.7021 1.5348* 23.5528 115.8178 62.3436 6.5998 18 LOAN/CA 3286.63 249.444 366.3793 60.2603 29.5122 3.7243* 19 C.R 90.8053 16.7484 86.7435 25.8149 0.5360* 23.2137 * indicates that null hypothesis is accepted.

1. TS+IH v/s HP: While examining the ratios for these two categories it is found that for four ratios out of nineteen, null hypothesis is accepted and for remaining ratios null hypothesis is rejected. The four ratios where no significant difference is found are: TI/TA, GP+D/TI, DIV/PAT and RETAINED EARNINGS/PAT. This implies that the majority of ratios differ between two groups. This is attributable mainly to their different nature of work. Out of these four ratios two ratios are same where null hypothesis is accepted in the overall analysis.

2. TS+IH v/s LF: On examining the ratios between these two groups for ten out of nineteen null hypothesis is accepted. These are marked with an * in the Table. It is worth nothing that for all the ratios falling in the category of leverage ratios there is no significant difference in these two categories. Here again two ratios are common with overall analysis. 3. TS+IH v/s LEASING: When TS+IH companies are compared against leasing companies only for one ratio i.e. GP/TI null hypothesis is accepted. This is attributable to their different nature of functioning. 4. HP v/s LF: When HP companies are compared with LF companies it is observed that for 7 out of 19 ratios null hypothesis is accepted. These ratios are GP + D/TI, GP/TI, PAT/TA, DIVIDENT/PAT, RETAINED EARNINGS/PAT, Bank borrowing / Total Assets and BB / B. It is apparent that the nature of functioning of both the types of companies is different. 5. HP v/s LEASING: When HP companies are compared with leasing companies it is in 6 out of 19 ratios that null hypothesis is accepted. The ratios for which null hypothesis is accepted are: PAT / NET WORTH, TAX / PBT, BOROWINGS / TA, Bank borrowing / Total Assets, DEBT/TA and CURRENT RATIO. It is obvious that the assets base of Hire purchase and Leasing companies will be different even though the nature of working are similar. This is because of the accounting treatment. In case of HP companies the companies do not remain the owner of the asset whereas in the case of Leasing the companies are the owner of the asset. This leads of the difference in the ratios like TI/TA and PAT/TA. 6. LF v/s Leasing: When loan finance companies are compared with leasing companies, it is for 9 out of 19 ratios that the null hypothesis is accepted. These ratios are: GP/TI,

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PBT/TI, DIVIDENT/PAT, RETAINED EARNINGS/PAT, Interest coverage, BB/TA, BB/B, D/TA and loan to current assets. Out of these 9,5 are common with HP v/s LF. From the table IV it follows that when two categories of NBFCs are taken separately the ratios for which null hypothesis is accepted changes. Conclusion On the basis of the study, it can be concluded that there exists a significant difference in the profitability ratios, leverage ratios and liquidity ratios of various categories of NBFCs. When two categories are examined against each other, then the more number of ratios are not statistically different from each other in majority of the cases except where TS+IH are compared with leasing. When all categories are taken together, null hypothesis is accepted for only three ratios indicating thereby that there does not exist a significant difference in only three ratios. From this it follows that the ratios for all categories of NBFCs are generally different from each other. The analysis of variance along with the details about average ratios may become a useful guide to companies to decide about diversification or continuation in the same line of business considering overall profitability within the regulatory framework. In brief, different categories of NBFCs behave differently and it is the entrepreneurs choice in the light of behavior of some the parameters which go along with the category of NBFC.
REFERENCES
1. Nabhis Law relating to Non Banking Financial Companies, A Nabhi Publication, 1994, pp. 1, 3, 5. 2. Reserve Bank of India Bulletin, August 97, p. 591 3. Machiraju H.R.: Indian Financial System, Vikas Publishing House Pvt. Limited, 1998, p. 7.1 4. CMIE, Monthly Review of Indian Economy, Dec. 1997, pp. 129-131. 5. Reserve Bank of India Bulletin, July 1998, p. 581 6. CMIE, Monthly Review of Indian Economy, May 1999, pp. 119. 7. CMIE, Monthly Review of Indian Economy, June 1999, pp. 110. 8. Seema Saggar, Financial Performance of Leasing Companies, During the Quinquennium Ending 1989-90 Reserve Bank of India: Occasional Papers, Vol. 16, No. 3 September 95, pp. 223-236. 9. Harihar T.S. Non-Banking Finance Companies, The Imminent Squeeze, Chartered Financial Analyst, February 1998, p. 40-47. 10. Reserve Bank of India Bulletin, August 1997, pp. 592-593. 11. Reserve Bank of India Bulletin Various issues, February 1991, May 1992, December 1992 etc. 12. Economic Times, Ahmedabad Edition, 26/3/99, p. 10 13. Bhole, L.M., Financial Institutions and Markets, Tata MC Graw Hill Publishing CO. Ltd., 1992.

14. Report of the Working Group on Financial Companies, Reserve Bank of India, Bombay, September, 1992. 15. Guide to Companies Act- A. Ramaiya, Twelfth Edition, Wadhwa and Company, Nagpur, 1992. 16. Dr. Guruswamy S., NBFCs The Rating Blues, Charterd Secretary, August 1998, pp. A169-A173.