Have A Major Marketing Tie-up

If any NBFC is not a captive finance company, it is advisable to have a major marketing tie-up.

This is mutual; both manufacturing company with whom the tie-up is done and the NBFC  - both get their top line at ease. Sourcing the business at dealer's/ distributor's purchase point is far easier than sourcing directly and through Direct Marketing Agents.

Even, cost of sourcing comes down dramatically.

Any defect in asset will be addressed rather quickly by asset manufacturer; service to the customer is better.
Deliquency will be very low; it is highly co-related and more so in the case of income earning equipments /assets.

Sales & marketing people of both company enjoy the synergy of the tie-up and they push themselves and their respective products rather with higher confidence.

If NBFC could offer to finance upto 20% of the product across the country or in the region where the NBFC has a strong presence, any manufactiuring company would like to pick up the 'losses' beyond a reasonable level, besides upfront fixed charge (%) for committment. However, NBFC would do better not to committ for the basket of products by the manufacturing company. Such 'basket' arrangement leads to conflicts and to break-up.

Also to be ensured by NBFC is that not more than 5% of their resources is depolyed for any such tie-ups.

Never Finance Discontinued Make/ Model

While financing auto assets, one should not finance model or make which are discontinued in the market.

There is always  a sudden drop in the value of those vehicles when discontinued for whatever reasons; the borrowers may not have interest in holding on to the vehicle and start defaulting on payments. The attitude changes with the imminent loss he may incur in holding the vehicle; he would be the first to know the discontinuance and the depressed value. Loan companies get to know the picture very late almost always.
Borrowers try to even overuse the vehicle, not maintain properly and not make installments so as to maximise his recovery of his equity/ margin in the asset quickly, before repossession.

In the market, forecasting a make or model discontinance is very difficult. When it happens, lenders must stop immediatly to avoid any further risk. The author even recommends to put on hold financing such makes/ models rumoured to be discontinued.

When loan companies come to know of the discontinuance, mark all those contracts as 'high risk' and monitor closely for early repossesion and disposal in case of 'high deliquency'.

Certainly, it is not at all advisable to consider financing used vehicles of those makes/ models even if the customer is highly rated or existing customer with good credit history.

Similarly, used imported vehicles must not be considered for financing; quality, spare avialability, value are suspect. Major frauds happen in metro cities in financing such vehicles.

Have An Economic Advisor

Finance is an important  part of Economics.

Elsewhere, I have argued that the finance business is 'interest centric'.

Please read: http://loganathan-pattabi.blogspot.in/2012/01/be-interest-centric.html

In my post-graduation in management with specialisation in two majors - marketing & finance - we had  more emphasis and many papers in economics. It had more coverage than a MA (eco.). We used to think that this was because we had a Director of the Institute who was an economist. The author did not realise the value of economics till he moved into senior positions where decisions ought to be taken.

Each decision involves capital investment, cost, return, demand, supply, etc. Suddenly, there is  economics  everywhere.

And economic growth is what drives the finance business at the macro level and economic cycles effect or affect the unit's top and bottom lines.

Being interest centric, it is important that any finance company or bank understands constantly where the economic cycle is and what company needs to tweek to optimise the resources and at least, not to get affected badly.

Another important work of an economist would be to forecast the interest rates and the length of the economic cycle so as to help negotiate the right rates and currency of the debt papers to be placed by the company and also correspondingly, subsequently and consequently decide the loan period for lending. Currently, banks and finance companies in competition, without much research and study offer as long as 7 years auto loan at fixed interest rates. If the interest rates are likely to fall in the 7 years contineously, it would be prudent to lend at higher fixed rates. It may be stupid if the interest are likely to increase. This is risky. Are banks and companies hedging? There are I believe some hedging rools available in the finance market. Are they using?

This is very important; it could help double the bottomline of any loan company/ bank.

An economist will also help discover new emerging assets for financing.

There was also a case where a company had lost huge customers and dealer finance business just because of bad attitude and lack of knowledge to understand the interest economics accurately and approprietly. A good understanding of the market, interest and economics by the country head and treasury head would have saved the business and eventually the company.

Economist apart, an MD or country head needs to have a knowledge of the economy and economics to succeed. He or she may have to have economic skill to set the right expectations  for an economist and from econmics.

A finance company used to decide the lending rates for car loans in a monthly meeting where author was present. The lending rates used to be about 10% less than the cost of Public Fixed Deposits. When questioned, the marketing ( lending) head would ask to shut up; the promoter would know better was the answer. It might not have been a case of not understanding such a simple arithemetic, if not economics. It was a fraud; company obviously went belly up.

Weighted average cost of funds and marginal cost of funds needs to be appropriatly collated and published to top management so as to reduce more discussion on lending rates. An economist would focus here to minimise constantatly both by innovative products and methods.

He or she can be even a consulting economist, if the company size does not suggest a  recruit.

A good practicing economist is something even RBI must think of prescribing to be on Board of Directors of any finance company, including MFI.

Appreciate , Liberally

Appreciate on every deserving occassion, liberally.

Greeting, thanking and appreciating geniunly would solve many HR problems in the corporate world and improve dramatically the relationship across the board and consequently the team spirit.

When I was working for a MNC finance company in India, I found myself in a utopian world and employees would not greet me; will respond to my morning greetings very relectantly. Neither they greeted each other. It was strange; I was never able to find a reason. Greeting each other must be an essential part of culture of any corporate; HR must watch out and ensure this. Or was it a problem of nepotism?; I was never sure.

Generally, mails are used for seeking approval or communicating news - both good and bad.
The author had an habbit of responding quickly; also to mails. If any mail carries any news with a semblance of goodness, the mail is read and replied quickly with one liners like :

• very good
• good progress
• excellent work here
• well done
• proactive
• Great job
• keep it up
• I appreciate your committment
• U r the best
• cheers

Most of mails are from branches and field collectors. Lot of regional managers conveyed that I was very popular among my field staff firstly for fast decision - either approval or dissapproval and secondly for 'appreciating' them on every occassion when they 'expected' - very promptly and very liberally.

Many managers feel that more and liberal appreciation would set high expectations among subordinates in terms of pay-rise, bonus and promotion. In fact, I found that employees would love to live with 'appreciation' in lieu of pay rise, etc.

Once, I had a good manager by name Mohanan to look after salvage - recovery from loss accounts. He was new to the company and started sending claims communications and legal notices in a few high value accounts. A mumbai based 'public relations' company was one of them to have received the notice. They had two accounts whose term were over and charged off and three more delinquent accounts with us. CFO of the borrower came down to chennai and negotiated for settlement of all 5 accounts together. The negotiation was cordial and ended positively; we took one full morning to do. After the successful negotiation, our MD ( an american who claimed to have had 25 years experience in debt collection in USA in the same company) had to question us as to why we were negotiating in very coordial atmosphere; he did see us through glass door. We were shocked; we were expecting 'appreciation", but we were a kind of reprimanded. To add further insult, another department head for whatever reason, had to say that the borrower was under pressure  for some foreign tie-ups to pay up and not because of any efforts by collection department. Obviously, we had lost Mohanan quickly to our competitor. Appreciate; at least do not insult or take away the credit.

“Appreciation is a wonderful thing. It makes what is excellent in others belong to us as well.” – Voltaire

Frederick Koenig once mentioned that happiness comes not from getting something we lack, but from the recognition and appreciation of what we do have.

“I would rather be able to appreciate things I can not have than to have things I am not able to appreciate.” – Elbert Hubbard

According to the Dalai Lama, the roots of goodness are in the soil of appreciation for goodness.

“Courtesies of a small and trivial character are the ones which strike deepest in the gratefully and appreciating heart.” – Henry Clay

Goethe said, “treat people as if they were what they ought to be and you help them to become what they are capable of being.”

Why not appreciate, little liberally? 

 

Listen To Disputes

Many customers or borrowers do have disputes, mostly while repaying loan.
They may not be wrong all the time.

Why disputes?

Disputes arise primarily because many applications are sourced by Direct Marketing Agents / Dealers in case of auto loans. An illustrative list of such disputes are as follow:

1. Agents and some employees make wrong promises, just to make a sale.
2. Many agents are neither knowledgeable nor reveal every fine print.
3. Customers are exited and do not read contract terms ; some may not fully understand all the jargons.
4. Many relate to monthly payments (EMIs) and/ or number of instalments.
5. Few relate to due dates.
6. A few but serious ones relate to rates, charges and penalties.
7. Also relate to the price of the vehicle, especially in case of used vehicles and the quantum of loan.

Many disputes aggrevate because

1. The customer does not know where to go
2. The loan company is not responsive
3. Collection agents just do not listen. Or insult
4. Company/ agent looks at every delinquent customer as bad / cheat.

Many disputed accounts are delinquent; because customers feel that that is the way to make the company to come over and listen.

It is important that company do have customer service departments to listen, note, investigate, explain or accept and conclude whether the dispute is genuine.

In case of delinquent customers, listening to the disputes and explaining as to how it is not / may not be disputable would solve 80% of the disputes. Subsequently and consequently, they would pay up.

Not willing to listen lead to aggrevating the problem and to a loss situation. If the dispute is allowed for a longer period and especially in case of deliquent customers, they learn not to pay and will become high risk account as the value of the vehicle will erode to be smaller than the loan receivable.

Listening attentively can also help unearth fraud situations.
Also, provide a window in the website for airing the dispute; let somebody track in head office.

Finding an honourable solutions quickly would help improve customer satisfaction and consequently customer retention.

So, listen to disputes carefully and find an amicable solution quickly.

Be focussd

Be focussd, because that is what ultimately pays.

It is not enough if you are knowledgeable; you need to be an expert in any field.
It is not luxary but a neccessity. This is not just true for individuals but also for organisations.

HDFC is a classic example for how successful focus could bring into organisation; it was started as  house financing comapany and it has remained so. Not that, there were no innovations; but, all of them were concentrated and focused on improving house financing business of the company. Now, it is one of the highly professional organisation and consequently highly rated - nationally and internationally.

Another shining example is Sundaram Finance Limited. They remained a vehicle finance company and largely a truck finance company. They certainly have all the nuances of this trade. That stood them during the crisis of 2000. They have been the true leaders in this field, undisputedly. Though they tried to focus also on car finance , that remained largely restricted to promote sales of their car dealerships.

Shriram transport was highly rumoured to go belly up about 15 years back for a lot of reasons; all of them might not have been fully true. They did not go belly up; on the contrary, they are big and beautiful today. Their share prices are one of the highest for any NBFC. The reason could be that they remain focussed on doing truck finance and more in sub-prime segment. They appeared to have developed an expertise in sub-prime truck financing pan india and they excell, I believe, in that segment.

More examples are from latest entrants; gold loan companies - Muthoot & Manapuram. They are focussed on gold loan and the author expects them to be successful if they stuck to pawn broking.

Lot of finance companies (NBFCs in India) , and even big ones cannot call themselves leaders in any segment. They are not focussed; they want to be in all segments to be fashionably called multi-product company, big company or diversified company, etc. The risk is added not diversified, as one would think.

One of the promoters had a policy: " emerge as a leader in a choosen category or exit". True to his statement, he exited his NBFC business. Once, his companies were leaders in car finance. He diversified into truck financing and merchant banking including corproate funding; his companies got into problem. He exited. He continues, I believe, with this policy even today.

In case of captive companies, they must remain not only focussed but also restricted to thier role to promote captive products. GMAC was brought into India as a captive finance company to promote sales of General Motors' chevy cars. Some smart CEO ( when GM was sturuggling to start in India) convinced higher-ups to diversify into financing all brands of cars and also used cars in India. This strategic deviation, which has never been done in other parts of the world, cost GMAC India's operations many millions. The focus / the purpose for which GMAC arrived in India is lost; so was the support to General Motors at a time when they desparetly needed their finance arm to help stabilise. GMAC survived for a decade; because they remained focussed on car finance. But, they have lost their relavance in India; General Motors learnt to live without GMAC. Newer bosses found the truth and pulled the plug. GMAC is gone; closure of the operation  cost the company, I have heard, about $ 20 million. It certainly did not earn as much in a decade of its existance in India. While the top brasses tried their level best to bring GMAC's focus on GM in the later years, local leaders could not succeed, partly because General Motors learnt to ignore GMAC. So, the penultimate Managing Director of GMAC went to the extreme to convince his immediate Spain boss to allow financing three wheelers in India. Obviously, nothing helped.

With more products, even CEO's attention span does not remain focussed; consequently, some products earnings would subsidise others. This may turn chronic and will lead to a serious crisis. There is a huge market for financing each product segment; select & stick to one.

And, be focussed. This minimises the loss and subsequent closure of the company.

Respect, The Non-Delinquent

No finance company/ institution can survive neither in short term nor in far term unless they have at least 80% non-delinquent customers/ borrowers in their retail loan portfolio at any given time. Most good companies do have a percentage exceeding 80%.

Can we call them 'good customers"?
Do executives have ever met these good customers? Almost, No.
Unfortunately, high risk and high delinquent customers are met more frequently and  more times.

In the current business model, thanks to concepts of head-count and out-sourcing, many of these customers are met/ handled face-to-face by company's Direct Marketing Agents, Dealers or Field Inspectors. Company hardly gets a chance to meet them unless company fails in its service delivery in the events of pre-closing, complaints like misapplication of payments, delay in issuance of No-Due-Certificate, etc.

Every marketing book says that retention of customers is important and retention is more profitable than acquisition of new customers. In my 30 years exposure in retail finance business, many companies tried and delivered better service to depositors, but not to borrowers. There is still a wrong stigma that borrowers are inferior and that companies do favour by lending them.  This has been changing at an increasing rate with increased professionalisation. Still, efforts to show ' respect' and 'appreciate' good customers are NOT being practised by even those so-called professional finance companies. They certainly care and respond.

Do not these good customers deserve little more so as to make them come back to the same company for additional or increased loan?

Firstly, there must be a customer service department / manager who handles every communication be it an enquiry, a service requirement or a complaint from any customer. Customers must be let known the contact details of customer service in all its communication including web-site, prominently. They certainly must prioritise the requirements and complaints from non-delinquent customers for solution, preferably in 2-3 working days, acknowledgement of receipt of their communication with service reference number within 1 working day apart. Speed of response is highly appreciated in customer service. More importantly, customer service must function in a way that there is no scope for complaint on them. Critical thing in customer service is delivering solutions continuously and consistently. Depending on the size of the company and service requirements, this department must be staffed in right numbers and quality. Obviously, this department/ manager must report to CEO or MD directly so as to analyse and facilitate to reenginner product, process and procedures so as to reduce the service requirements and improve quality.

Secondly, there must be a communication with these customers from some seniors from head office, preferably CEO or MD on occasions like new product launches, etc. In trying to further enhance brand equity, a greeting on Birthdays to all good customers with an appreciation of their promptness and good account history would go a long way to get referrals and also additional or increased business from these customers. This needs  to be done accurately, being continuous and consistent apart. Nobody likes to get greetings a week later, right?

When the author was a marketing manager in a captive finance MNC, this concept was introduced.  Many customers were happy, thankful and appreciative. With in a year, the MD who happened to be a bean counter, shelved the project as a cost-cutting measure. He was subsequently, obviously and deservedly dismissed for many other reasons; I wish that he was dismissed for this reason alone. Believe me, bean counters ought to be CFOs and they can never make good CEOs or MDs.

So, build brand equity around these good customers by respecting and appreciating. It is no more a luxury but necessity.

RBI Fingers Gold Loan NBFCs

Proactive RBI.

It is strange and good to find elephant dancing;
Yes, RBI is proactive this time.

Reserve Bank of India ( RBI) has come out with rugulatory guidelines for Gold Loan NBFCs on March 21, 2012. Surprisingly, this is even before any scam by any unscruplous finance company.

No doubt that gold is a good underlying asset; but, there is a huge operational and market risk  running a gold loan company. Operation risk is manageable and is within the influence of the management of these NBFCs. Market risk is unmanageable, hence regulatory guidlines.

No wonder, this business has been dominated by Marwaris as a family business; a family member is responsible for evaluation, grading, LTV and storage of collaterals. The interest rates and LTVs are decided by the community informally; they know full well the risk involved in this business. Believe me, their interest rates are simple and is lower than the rates charged by many Gold Loan NBFCs.

Their service accessibility is 24 X 7 X 365; NBFCs may not be able to match here. Ones that match would do too well.

More importantly, Marvaris do not have the problem of "managing" NPA.
Collection problem is zero though losses may still happen due to many other reasons, maily while realising the value from the pledged but high delinquent ( NPA accounts).

Advantage with Gold Loan companies has been "high LTV". This is precisely the risk.

Gold prices had been increasing for the past 11 years and at increasing rate in the past two years. With fear of global recession receding and Europe's crisis is being solved, the gold can retreat upto
20-30% from the recent peak. Hence, the guidline of LTV not to exceed 60% is welcome and an important feature.

But, it is perflexing as to why RBI banned loans on bullion / primary gold and gold coins by NBFCs. Are NBFCs expected to achieve any social objectives? Is RBI looking at as a high potential fraud area?

And what is the reference rate for gold for valuation of gold jewellery which are made at varying karats? This is bigger risk than LTV. Will RBI address this ever?

Why are banks allowed to take risk (no restriction on LTV)?
And, where is the level playing field?

RBI / 2011-12/467

DNBS.CC.PD.No.265/03.10.01/2011-12 March 21, 2012

To

All NBFCs

Dear Sir,

Lending Against Security of Single Product – Gold Jewellery

It is observed that NBFCs that are predominantly engaged in lending against the collateral of gold jewellery have recorded significant growth in recent years both in terms of size of their balance sheet and physical presence. This in turn, has led to their increased dependence on public funds including bank finance and non-convertible debentures issued to retail investors.

2. Given the rapid pace of their business growth and the nature of their business model, which has inherent concentration risk and is exposed to adverse movement of gold prices, as a prudential measure, it has been decided that all NBFCs shall

i. hereafter maintain a Loan-to-Value(LTV) ratio not exceeding 60 percent for loans granted against the collateral of gold jewellery and

ii. disclose in their balance sheet the percentage of such loans to their total assets.

3. NBFCs primarily engaged in lending against gold jewellery (such loans comprising 50 percent or more of their financial assets) shall maintain a minimum Tier l capital of 12 percent by April 01, 2014.

4. NBFCs should not grant any advance against bullion / primary gold and gold coins.

5. Copies of Amending Notifications No. DNBS.241/CGM (US)-2012 and DNBS.242/ CGM (US)-2012 of date are enclosed for meticulous compliance.

Yours sincerely,

                                                                                                                (Uma Subramaniam)

Gold, A Good Underlying Asset

Many NBFCs are venturing into Gold pawn broking / mortgage business in recent times.
It is important that they know the underlying asset in detail; the author has tried to give you What, Why, When, Where and How of gold in the following paras.

Please read a page on "Gold Trends in 2012" by the same author to get an idea as to what should be the LTV and loan per gram of gold. http://india-moneyfactory.blogspot.in/2012/01/gold-trend-in-2012.html

Higher operational risk in this business is discussed in a separate page.

What is Gold?

Gold (with atomic number 79 and atomic weight 197.2) is a “butter” yellow metal. Its melting point is 1063 ^oC, boiling point is 3081 ^oC and specific heat at 298 ^oK is 1.288 x 10-1 J/g.K. Its best Field Indicators are color, density, hardness, sectility, malleability and ductility.

Gold purity is measured in terms of karats and fineness. Pure gold is defined as 24 karat.
Thus, 18 karat = (18/24) th of 1000 parts = 750 fineness (parts per thousand).

Why Gold?

The term gold is said by the scholars and philologists, to come from Sanskrit jvalita, derived from jval to shine. The word gold derives from the Anglo-Saxon gold, a word apparently corrupted from the Teutonic gulth glowing or shining metal. The Latin term of gold, aurum, and the earlier Sabine ausum are said to be words to early Italian origin related to aurora meaning glowing down. Another version has it that the Latin word aurum derives from the Hebrew aor meaning light. The Latin term is preserved in the chemical symbol for gold, Au, and in the terminology of its salts, aurous and auric.

Why Gold is precious?

Gold is one of the metals less active. Thus, do not suffer oxidation neither in air nor oxygen, for this reason is called noble metal. Gold is a very stubborn element when it comes to reacting to or combining with other elements.

There are very few true gold ores, besides native gold, because it forms a major part of only a few rare minerals, it is found as little more than a trace in a few others or it is alloyed to a small extent with other metals such as silver.

Gold is almost indestructible and has been used and then reused for centuries to the extent that all gold of known existence is almost equal to all the gold that has ever been mined. Gold is a great medium metal for jewelry as it never tarnishes.

Gold has intrinsic beauty and great malleability.

Gold was a global currency once and continues to be playing the similar role even in current times.

When was & Where is Gold found ?

Early references to the first discovery of gold are essentially legendary or mythical. Thus, Cadmus, the Phoenician, is said by some early writers to have discovered gold; others say that Thoas, a Taurian king, first found the precious metal in the Pangaeus Mountains in Thrace. The Chronicum Alexandrinum (A.D. 628) ascribes its discovery to Mercury (Roman god of merchandise and merchants), the son of Jupiter, or to Pisus, king of Italy, who, quitting his own country went into Egypt. Similar legends and myths concerning the initial discovery of gold are extant in the ancient literature of the Hindus (the Vedas) as well as in that of the ancient Chinese and other peoples. In fact, the discovery of the element we call gold is lost in antiquity.

The principal source of gold in primitive times was undoubtedly stream placers, although there is considerable evidence in certain gold belts (e.g., Egypt and India) that alluvial deposits, auriferous gossans, and the near surface parts of friable (oxidized) veins were mined.

The total above ground stocks of gold is estimated to be around 1, 63,000 tonnes by Gold Fields Minerals Services (GFMS) as on end of 2008. Out of this total stock, 51% is estimated to be present as jewellery, 18% as official reserves, 17% held as investment, 12% used for industrial purposes and 2% is unaccounted for.

Jewellery accounts for almost two-thirds of annual gold demand with investment and industry being the other main drivers. The total annual global demand for gold has averaged 3530 tonnes in the last three years (2005 - 2008). However, it is expected to dip slightly in 2009, owing to the sharp rise in prices.

Five countries, viz., India, China, USA, Turkey, Saudi Arabia and UAE account for above 60% of gold demand, with each market driven by a different set of socio-economic and cultural factors.

The total global mine production is relatively stable, averaging approximately 2,455 tonnes per year over the last three years. Recycling of old gold scrap and official sector sales are the other major sources of supply, which have averaged 1084 tonnes and 378 tonnes in the last three years.

South Africa has been a major gold producer since 1880s and it is estimated that about 50% of all gold ever produced has come from this nation. While, during the early 1980's it produced about 1000 tonnes, the output in 2007 dropped to just 272 tonnes.

China with a production of 276 tonnes, overtook South Africa as the world's largest gold producer in 2007 for the first time since 1905. The other major producers are USA, Australia, Russia and Peru.

How is Gold measured?

Weight Conversion Table

To Convert From-                   To -                                                         Multiply by

Troy Ounce-                            Grams-                                                    31.1035
Grams-                                     Troy Ounce-                                           0.0321507
Kilograms-                               Troy Ounce-                                           32.1507
Kilograms-                               Tolas-                                                      85.755

Does Tractor Finance Make Sense For NBFCs?

Agriculture labour has become scarce and costly, thanks to migration of labour to other activities in rural and urban areas. Hence, use of agriculture equipments and implements are growing at increasing rate. Main such equipment is tractor.

Majority of tractors are sold on credit. Private (non-foreign banks) and PSU banks have been financing tractors’ purchase in rural area for agricultural purpose for a long time; they also finance short term and medium term loan requirements of farmers like crop loan, etc. They have a credit history of farmer-customers.

Indian banks are regulated and required to lend to priority sector within which agriculture falls. Agriculture lending needs to be 18% of the net banking credit of any bank. There is a pressure on banks to meet this target annually. Besides, Government of India and in certain cases, state governments announce periodically write-off of past dues of agriculture loans partly or in full; banks are made good the losses out of write-offs, by the government.

Some of tractors owned by big farmers are also used for transportation of agriculture produce, especially sugarcane to nearby sugar mills.

Also, land holding is getting marginal, thanks to transfer of lands to landless, break up and fragmentation of families.

A tractor is fully employable only if the family owns at least 30 acres of land.  In all other cases, it does not become economical unless it is hired to others for agriculture and transport purpose. Many marginal farmers are currently buying tractors for hiring and make decent income. Can they be put to use through out the year?

Banks especially PSU banks lend at very low rates and for loan periods up to 84 months. Land Development banks lend at thr lowest rates and for periods up to 10-15 years on mortgage of lands. Regional rural banks are also active in this segment. Repayment term is either quarterly or half-yearly.

Bank finances are economical, suitable and comfortable for any rural borrower.  Banks are too eager and prefer doing tractor finance as it is asset based; repossession is technically possible.

Where does NBFCs figure?

Captive finance companies like Mahindra are aggressive because they get finances at good discount from NABARD and Indian Banks; and they have vested interest to push their product. There need not be any other reason for such companies not to be in this segment.

Why should other finance companies be in this business?

They need not be,

·         Unless they get substantial subvention from manufacturer to cover their possible losses

·         Unless they are greedy to be in every product finance business

·         Unless they are desperate to get a part of priority lending funds at lower rates from Indian banks and NABARD

·         Unless they have a good experience already in the rural market

·         Unless they are lending in areas where water is abundant and two crops are raised

·         Unless they want to be a good social citizen, playing a leadership role in the development of rural India

Tractor finance, credit and past due collection

Incomes of farmers are not regular; they are subject to vagaries of nature. So are collections. They are mostly at the interval of 6-12 months. Their banking habits are increasing and are not satisfactory yet. Cash collections are predominant; keeping track of harvest and monetisation is increasingly difficult, cost of tracking being very high apart. Customers’ concentration is sparse and it requires more field collectors. Come along also are the risk of monitoring the field collectors, cash handling and transportation of cash.

Repossession of asset by PSU and land development banks is almost nil; private banks and NBFCs are actively resorting to repossession. Farmers are highly egoistic and emotional; this creates problem of repossession. Most of the times, they intentionally keep them impaired and un-motorable, to avoid easy repossession.

Credit assessment is crusial. Involve as many joint applicants and guarantors as possible; get reputed guarantors like panjayat ex or current president, etc. Briefly, they do not pay up unless there is peer pressure.
Currently, many of the farmers’ heirs are working for regular income in urban centres. It is advisable to learn and involve such regular income family member as either applicant or guarantor.

In brief, it is avoidable by NBFCs.
If not huge losses, this product will not make big money for any finance company in the far term.

Be Interest Centric

An interest rate is the rate at which interest paid by a borrower for the use of money that they borrow from a lender.

For banks and finance companies, interest is the input as well as output. They borrow for interest and lend for interest. Their performance and goals are centered on interest receipts and interest payments. Gross profit of any finance company is nothing but the difference between interest earned on funds deployed and interest paid on their borrowings. As a thump rule, 30 - 40% of assets financed of any finance company is either received or paid by the name interest. It is too huge a component in profit and loss account to be ignored. Unfortunately, it does not get focused, though not fully ignored.

Do companies have a control on these? Will floating rate and / or fixed rate borrowing and / or lending solve the problem? Is risk measured? Do they hedge risk?

Foreign banks and MNCs remain focused on interest, though they do not appear to measure and mitigate risk in any scientific manner. They certainly focus on and decide appropriately ‘marginal cost of borrowing’ and ‘marginal price of lending’. They decide to borrow only if they can get at least 6-7% of marginal profitability (the difference between marginal cost of borrowing and marginal price of lending).

Marginal cost of borrowing is the incremental cost of borrowing more money to finance additional assets. Simply, it is the interest rate on the newer loan balance. Marginal cost of funds is often confused with the average cost of funds, which would be calculated by computing a weighted-average of all the combined loans’ interest rates. Similarly, marginal price of lending is the interest rates charged for new contracts / lending.

Many companies just keep raising the money like there is no tomorrow, at any interest rate and keep deploying at rates irrelevant to marginal cost of borrowing and at times even at lower rates than the average cost of funds. This creates disequilibrium and leads to unremunerative activities and consequently to operational loss. This is within the influence of top management. They may decide two important things here: 

1. Not to lend at rates less than marginal cost of borrowing; that requires tracking and publishing cost of funds accurately every month to the top management by CFO.
2. Rate of (profit) premium that the company must charge over marginal cost of borrowing to arrive at marginal price (interest rate) of lending. Why should they borrow if they cannot deploy funds profitably?

Most of the credit rating agencies focus on asset-liability match and fund flow match for the short term say a year; they do not seem to be testing the process of pricing in banks / finance companies. Many finance companies make higher profits from fees, charges and salvage than from core lending.

Of course, some finance companies are capable of making profits from the air; they certainly require strong top line, with no regard to any rate.

In retail finance market, most lending is done on fixed loan rate. Floating rate short term loans are not popular and impractical.

But, finance companies have a combination of floating rate and fixed rate bonds and loans in their borrowing portfolio.

If the borrowing rates are falling, finance companies stand to gain abnormally. Risk comes alive when floating rates rise; companies are forced to poke out additional interest cost from their pocket.

Some of the housing finance companies started lending at floating rates; the question remains whether they fully match floating rate borrowing with floating rate lending in tenure and quantum. If they don’t, they still run the risk.

Finance companies are advised to hedge interest rate risk by recognizing, measuring and adopting the right mitigating strategies like interest rate swaps, buying derivatives - interest rate futures, options, etc.

Or, simply borrow at fixed rate, lend at fixed rate and keep a minimum gross margin of 5-7%.