Risk Management in Non Banking Financial Companies (NBFC) Case Studies on IL & FS, DHFL and Bajaj Financial Ltd.

1. Domain : Finance
Risk Management in NBFC
Project Risk Management
Assignment No. 2
Group Members:
Sumeet Milton Main (182200030)
Akshay Goyal (182200003)
Pooja Virkar (182201020)
Bincy Babu (182201021)
Durgesh Singh (182200018)
Shashank Kotkar (182200014)

2. NBFC
A Non Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 of India, engaged in the business of loans and
advances, acquisition of shares, stock, bonds, hire-purchase insurance business or chit-fund business but does not include any institution whose
principal business includes agriculture, industrial activity or the sale, purchase or construction of immovable property.
The working and operations of NBFCs are regulated by the Reserve Bank of India (RBI).
NBFCs cannot outsource core management functions like internal audit, management of investment portfolio, strategic and compliance functions for
know your customer (KYC) norms and sanction of loans.
Role of NBFC
• Financing economically weaker section
• Supplementary role to the banks.
• Exclusively lending to the infrastructure sector and provide long term
credit
• Attracting foreign grants. Some NBFCs cater to specific sectors like
renewable energy and thus attract foreign grants in these sectors.
• Mobilization of funds for startups and MSMEs.
• NBFCs also diversify the financial sector, reducing the overall risk in the
economy. If not NBFCs then money will get concentrated in few giant
banks.

3. NBFC vs Bank
Salient Features of NBFCs
• The NBFCs are allowed to accept/renew public deposits for a
minimum period of 12 months and maximum period of 60
months. They cannot accept deposits repayable on demand.
• NBFCs cannot offer interest rates higher than the ceiling rate
prescribed by RBI from time to time. The present ceiling is 12.5
per cent per annum. The interest may be paid or compounded at
rests not shorter than monthly rests.
• NBFCs cannot offer gifts/incentives or any other additional
benefit to the depositors.
• NBFCs (except certain AFCs) should have minimum investment
grade credit rating.
• The deposits with NBFCs are not insured.
• The repayment of deposits by NBFCs is not guaranteed by RBI.
BASIS FOR COMPARISON NBFC BANK
Meaning
An NBFC is a company that
provides banking services to
people without holding a
bank license.
Bank is a government
authorized financial
intermediary that aims at
providing banking services to
the general public.
Incorporated under Companies Act 1956 Banking Regulation Act, 1949
Demand Deposit Not Accepted Accepted
Foreign Investment Allowed up to 100%
Allowed up to 74% for private
sector banks
Payment and Settlement
system
Not a part of system. Integral part of the system.
Maintenance of Reserve
Ratios
Not required Compulsory
Deposit insurance facility Not available Available
Credit creation NBFC do not create credit. Banks create credit.
Transaction services Not provided by NBFC. Provided by banks.

4. Classification of NBFI's
Reserve Bank
of India
NBFCs
IC
LC
AFC
IFC
IDF
MFI
Factor
CIC
RNBC
Ministry of
Corporate Affairs
Nidhi
Companies
State Registrar of
Chit Funds
Chit Funds
National
Housing Bank
Housing
Finance
Companies
IRDA
Insurance
Companies
SEBI
Merchant
Banker
Broker/
Sub-broker
Venture Capital
Fund Company
Stock
Exchanges
MGC

5. Typical Causes of Financial Crisis
The root causes of financial crises have been classified as follows:
Asset (Loan) Quality: Asset quality is an evaluation of asset to measure the credit risk associated with it. Poor asset quality rating means high NPA's
(non performing assets).
Asset-Liability Mismatch: Banks and financial institutions have assets and liabilities of different maturities. This exposes them to Interest Rate Risk
and Liquidity Risk.
Fraud: Poor risk management processes have resulted in frauds in large institutions.

6. Issues plaguing NBFCs
Economy & Business Issue
• Cut throat competition from other banks. Banks are also coming up with innovative financial solutions thus giving tough competition to NBFCs.
• Non Performing assets (NPA) and slow Industrial growth. Both NBFCs and banks are suffering from NPA crises.
Weak Regulation and Corporate governance
• Weak Capital Structure – Since NBFC is not a bank under RBI Act. The monetary policies like CAR, CRR, SLR etc are not applicable to them and
hence they lend beyond their limits which ultimately creates a weak capital structure. Most of the NBFCs work on very thin equity capital base.
• Management Issues – NBFCs are facing management which lacks transparency and accountability.
• There is a tussle between Reserve Bank of India (RBI) and the Government regarding opening a special window to provide funding to NBFCs as
the RBI is concerned of moral hazard and other sectors demanding the same.
• Failure of rating agencies – there is a conflict of interest as rating agencies are paid by the issuers whose securities they rate. Recently rating
agencies did not monitor liquidity shortage at IL&FS and gave it AAA ratings; this was downgraded to junk after the crises unfolded.

7. Issues plaguing NBFCs
• After the IL&FS crisis SEBI on 13th November 2018 issued a new circular where credit rating agencies (CRA) will now have to disclose the
liquidity position of the companies they rate.
• New Accounting policies – The new Indian Accounting Standards (Ind-AS) is applicable to NBFCs from April 1, 2018. Loan-loss provisioning will
now have to be made on expected credit loss (ECL) model, based on past trends and judgments of individual entities. However in long term
this shift will result in stronger NBFCs, presently, it could see the net worth of many companies fall by as much as 10%.
Liquidity Crisis
• The sector is facing a liquidity crunch – NBFCs mostly generate liquidity through market borrowing and bank borrowing. At present due to
mounting amount of NPA, banks are hesitating to lend anymore to NBFCs and market borrowing through bond or commercial paper is facing
big difficulties.
• Banks have also restricted lending to the NBFCs as their ratings have turned poor. This has added to the crunch and reduced profits margins.
• NBFCs have started selling their stocks due to loss of leveraged positions. This has set off sales in other stocks as well, thus starting a vicious
cycle.
There is an urgent need to stem the issues and crises being faced by the NBFC sector. Some external funding is essential to provide liquidity. In the
long run, better institutional regulations and monitoring must be in place to prevent such asset – liability mismatches.

8. Types of Risks
Credit Risk
A credit risk is the risk of default on a debt that may arise from a borrower failing to make required payments.
Liquidity Risk
Liquidity risk is the non-availability of cash to pay a liability that falls due.
Market Risk
Risk of loss due to price movements in any market the institution is trading in, such as currency, stocks, bonds, commodities etc.
Operational Risk
Operational risk is the risk of loss due to errors, breaches, interruptions or damages—either intentional or accidental—caused by people, internal
processes, systems or external events.

9. Credit Risk
Repayment track with others
The repayment track of the borrower with others determines how well they have carried out their business in the past years.
Resale value of the asset financed
In case of default on the part of customers to repay the loan, the bankers will look to seize the asset and realize the due amount from it.
Percentage funding to total cost
Lower ratio means more contribution from the borrower and the risk on the banker’s end is low.
Value and liquidity of collateral offered
The higher the liquidity is, the better the collaterals.
Timely submission of information
The customers are required to be prompt in submission of information.

10. Liquidity Risk
The coverage ratios show the relationship between the debt servicing commitments and the sources for meeting these burdens.
Debt Equity Ratio
The ratio brings out the extent to which the firm is dependent on outsiders for its existence and indicates the proportion of the owners’ stake in the
business. A high ratio means that claims of creditors are greater than owner’s funds. Excessive liabilities tend to cause insolvency. This is the most
unfavorable situation for a banker, as he may gain the position of just one among the many creditors of the company.
Current Ratio
The current ratio is an index of the concern’s financial stability since it shows the extent of the working capital, which is the amount by which the
current assets exceed the current liabilities. A high current ratio indicates inadequate employment of funds while a poor current ratio is a danger
signal to the management. It shows that business is trading beyond its resources. Current ratio of 2 is ideal.
Liquidity Ratio
This ratio is also an indicator of the short-term solvency of a firm. Ideal ratio is 1:1.
Interest Coverage Ratio
It tells the analysts the extent to which the firm’s current earnings are able to meet current interest payments.
Debt service coverage ratio
The standard ratio is 1.5. However, if the ratio is between 1 and 1.5, suitable spacing of the repayment period and thereby lowering the annual
repayment obligations, may raise the ratio and make the proposal financially viable.

11. Market Risk
Nature of the Business
The kind of business in which the customer is in will greatly influence the risk associated with him.
Net Worth to Net Sales
The net worth of a business provides that important cushion to withstand shocks from adverse changes in external (economic, financial and legal)
and internal environments of the business. Net worth is thus referred to as the risk capital. When compared to the sales of the business, it shows the
efficiency with which the capital is rotated in the business.
Reputation of Promoters
The promoters are the ones who initiate a business idea successfully. The background of the promoters gives an idea of their business expertise and
their talents.
Technology Status
Obsolescence is another problem that an industry faces. A firm’s competitive position is decided based on the technological competence it
possesses.
Effect of Business Cycle
Almost every industry suffers from some amount of cyclical fluctuations. A business which is least impacted by the business cycle would be an ideal
borrower.
Government Policies
The pace and pattern of growth in a country depends largely on various policies of the Government. It acts as a regulator and a mediator between
the businessmen and the public. When the government policies are friendly and favorable towards the industry, then the growth prospects are high.

12. Operational Risk
People
Even in a digital age, employees (and the customers with whom they interact) can cause substantial damage when they do things wrong, either by
accident or on purpose. Problems can arise from a combination of factors, including intentional and illegal breaches of policies and rules, sloppy
execution, lack of knowledge and training, and unclear and sometimes contradictory procedures.
Systems
Systems can be hacked and breached; data can be corrupted or stolen.
Organizational Structure

15. IL&FS
Background
In 1987 IL&FS was formed by three financial institutions, Central Bank of India, Housing Development Finance Corporation
(HDFC) and Unit Trust of India (UTI), to provide loans for major infrastructure projects.
Infrastructure Lending and Financial Services (IL&FS) has more than 250 subsidiaries.
IL&FS has financed some of the largest infrastructural projects in India – for e.g. Chenani-Nashri tunnel (longest road tunnel
in India) & is considered as a pioneer in PPP projects.
IL&FS was envisioned to provide long term big infrastructure loans which the banks were reluctant to provide.
From July to September 2018, two subsidiaries of IL&FS’s reported having trouble paying back loans and inter corporate
deposits to other banks and lenders, resulting in the RBI requesting its major shareholders to rescue it. Recently,
Government of India has taken control of IL&FS’s, after it failed to pay off debt payments. Since this move by the
government there has been an increase in volatility in the stock markets. A new board was constituted as the earlier board
was deemed to have failed to discharge its duties. The new board consists of Kotak Mahindra Bank managing director Uday
Kotak, former IAS officer & Tech Mahindra head Vineet Nayyar, former Sebi chief G N Bajpai, former ICICI Bank chairman G C
Chaturvedi, former IAS officers Malini Shankar and Nand Kishore.
IL&FS has been recognized as systematically important institution due to the size of Infrastructure projects it funds. If IL&FS
fails then there will be repercussions in various fields.

16. Reasons for failure of IL&FS
Lack of regulators
• Rating Agencies – The rating agencies gave IL&FS an AAA rating and this encouraged investment in
the company but now they have changed the rating of IL&FS as junk.
• Shareholders – Major shareholders failed to monitor the company that they invested in.
• Board of Directors – All the senior officers have resigned from their posts.
• RBI – RBI is considering itself a regulator today but it could have monitored the situation before the
crisis unfolded.
• Government of India –It never properly assigned any regulator.
Source and use of funds
• Increase in interest rates of short term borrowings.
• Loans skewed in the long term – Most debts that IL&FS had to pay off were short term while the
loans it had granted were majorly long term.
• Lacking transparency in financial position and too many loans to own subsidiaries.
• No clear distinctions between public & private projects.
Complex company Structure
Too many subsidiaries – with more than 250 subsidiaries, the auditing and monitoring of the company
difficult for any auditing firm or regulator.
Ethical Issue
Crony capitalism – there have been known cases where things were hidden deliberately & unviable
projects were sanctioned to please the ruling parties.

17. Effects of IL&FS crisis
• Loss of confidence of investors.
• Many mutual funds have invested in its Bonds, Certificate of Deposits. The default and further fear of default is contagious to all financial markets
which resulted in loss of money for many investors during last few months.
• Banks have reported an exposure of nearly ₹20,000 crore to debt-ridden Infrastructure Leasing and Financial Services (IL&FS). (TH)
• More than 50 retirement funds covering over 15 lakh employees have exposure to IL&FS. (ET)
• Government decision to pump more funds to meet with crises can result in widen of fiscal deficit which has adverse repercussion on inflation,
exchange rate, growth etc.
• It can lead to diversion of funds which were meant for social sector programs.
• One of the key prongs for the welfare of ex-servicemen -- the Army Group Insurance Fund (AGIF) -- has exposure to toxic IL&FS bonds amounting
close to Rs 210 crore. This means that crores worth of insurance premiums, covering all ranks from generals to JCOs and jawans, are at risk of
being lost. (ET)

18. Solution
• The Mumbai bench of National Company Law Tribunal (NCLT) found favour with government's arguments to oust the current board of
Infrastructure Leasing & Financial Services (IL&FS) and appointed Kotak Mahindra Bank's managing director Uday Kotak as non-executive
chairman.
• The government has categorised IL&FS group entities into green, amber and red categories based on their respective financial positions. Entities
classified as 'green' would continue to meet their payment obligations, while 'amber' category firms can meet only operational payment
obligations to senior secured financial creditors. Those falling in the 'red' category are the entities which cannot meet their payment obligations
towards even senior secured financial creditors.
• The new management is also developing a liquidity management framework and has been able to drive down monthly operational costs by 28%
between October 2018 and March 2019. (ET)
• The Kotak-led board hopes to resolve the assets of the group by mid-2019. IL&FS, with a debt of Rs 99,000 crore, has put many assets on sale,
including energy, education and road, to monetise investments and repay the creditors.
• The Serious Fraud Investigation Office (SFIO) arrested Hari Sankaran, former managing director and vice-chairman of Infrastructure Leasing and
Financial Services, in connection with ongoing investigations into defaults at IL&FS and its subsidiaries last year.
• Simplifying the complex structure of IL&FS.

19. Steps to be taken in future
• Making stringent laws to deal with lack of transparency in both companies structure and finances as well as rating agencies.
• Auditing should be done by independent third party auditors appointed by the government in consultation with RBI and major shareholders. This
will ensure greater transparency in auditing of financial records.
• Minimizing red-tapism, reducing excessive paperwork to avoid stalling of projects.
• Fast tracking land acquisition and environment clearances.
• Bringing NBFC's properly under the ambit of SEBI or RBI.
• Board of directors should be held accountable for such major defaults and should be brought under regular audit mechanism.
• The government can look at disinvestment of deteriorating assets rather than bailing them out from the tax payers money.

20. DHFL
• DHFL was established and incorporated by Rajesh Kumar Wadhawan on 11 April
1984.
• As of June 2018, DHFL has 209 branches and 113 service centres. It also has
representative office in London.
• In 2010, DHFL acquired Deutsche Postbank Home Finance unit for ₹1079 crores. On
18 December 2013, DHFL acquired 74% stake DLF Pramerica Life Insurance Company
Ltd.
• DHFL is the second housing finance company to be established in the country. DHFL
is among the 50 biggest financial companies in India.
• DHFL is rated CARE AA+ by ICRA Limited and achieved BWR FAA+ from Brickwork
Ratings, which indicate the high degree of safety regarding timely servicing of
financial obligations.
• Housing finance companies mostly focus on providing loans but DHFL accept
deposits also, so as to increase business model, diversify portfolio and generate
more revenue.
• Products of DHFL are FINANCE and DEPOSITS

21. Reasons for DHFL Crisis
• Media outlets have speculated that the real estate market has been struggling under policy pressure such as RERA, GST and demonetization.
• IL&FS made an interest default hence its rating went down to D. A debt fund of DSP Mutual Fund named DSP CREDIT RISK FUND was holding IL&FS
commercial Paper (CP).
• Redemption pressure came to this fund . Hence DSP MF sold AAA rated 9.1% paper of DHFL as they needed big fund and hence this quality paper
was sold at a steep discount to meet the redemptions.
• The Bond was sold at 18% steep discount (Rs.100 bond sold at Rs. 82).
• This sparked concerns about DHFL's ability to raise money from the market at a feasible rate. For one, DSP was finding it quite challenging to find
takers for the instrument, even at 11 percent. If a fund house is forced to sell 1-year commercial paper at 11 percent, there is apparent that no
one is willing to buy it. As a result, investors' outlook on DHFL's stock weakened and they started selling its shares in panic, pulling it down by over
55 percent intraday

22. Effect Of DHFL Crisis
• Doubts about DHFL eventually spread to other housing finance companies and later to other non-banking finance companies (NBFCs). Stocks of
Indiabulls Housing Finance and LIC Housing Finance were also down by over 20 percent and 15 percent.
• NBFCs, struggling to raise money from institutions, have successfully tapped the retail segment.
• Heavy selling was also witnessed in healthcare, banking, IT, auto, tech, power consumer durables, FMCG, capital goods, infrastructure, metal and
PSU indices, which fell up to 3.65% .

23. Steps Taken For DHFL Crisis
• The Government will take all measures to ensure that adequate liquidity is maintained/provided to the NBFC's.
• DHFL continue to sell bundled loans and aim to reduce its developer finance book by 50%. It would offload non-core assets to boost capital.
• DHFL is raising funds by selling its bond at lower rate.
• DHFL is selling 80% stake in Aadhar Housing to BlackStone.

24. Bajaj Finance Ltd.

25. Bajaj Finance Ltd.

26. How BFL is Better than others?

29. Thank You.