Watch our latest edition of JSA Live, where our Partner Prakriti Jaiswal provides insights into the dynamics of dealmaking in the NBFC sector.
Transcript
The NBFC sector in India has experienced significant growth, firmly establishing itself as a pivotal player in the country's financial sector. NBFCs are highly regulated entities, primarily overseen by the RBI. Previously categorized as systemically important and non-systemically important, a new classification system based on layers (i.e. base, middle, upper, and top) was introduced by the RBI in October 2023, streamlining the processes and compliance requirements.
M&A activity within the NBFC sector has been on the rise. Any significant change in ownership or control requires RBI approval. Depending on the nature of the transaction, the approval process involves evaluating the financial soundness of the acquiring group, its capability to manage the NBFC's operations,the fit and proper criteria, source of funds, and experience in the sector. The approval process can take anywhere from 3-6 months. This regulatory framework aims to mitigate risks associated with abrupt ownership changes and promotes the stability and reliability of the NBFCs. Understanding and navigating these regulations is crucial for the transaction success.
From a due diligence standpoint, the investors typically scrutinize aspects such as the asset composition, loan portfolio quality, risk management practices, and potential liabilities or NPAs that could impact valuation and future performance. From a legal diligence perspective, NBFCs generally exhibit higher structural organization, compliance standards, and governance levels compared to other sectors. From a business standpoint, NBFCs often see synergies with other BFSI sectors, which requires us to analyse these ancillary business to ensure they don't flout the regulatory framework.
Other key aspect is that NBFCs often operate with higher leverage ratios relying extensively on borrowed funds, such as commercial paper, debentures, and bank loans. Unlike banks, NBFCs typically do not accept deposits from the public, which can make their funding more volatile and dependent on market conditions. Higher leverage can amplify both potential returns and risks for NBFCs, as they may face greater sensitivity to fluctuations in interest rates, credit quality, and market liquidity. Regulatory bodies closely monitor NBFCs to ensure that their leverage levels are sustainable and do not pose systemic risks to the financial sector.
Overall, with favorable demographic trends, increasing financial literacy, and supportive regulatory measures, NBFCs in India are expected to continue playing a significant role in the financial ecosystem and contribute positively to economic development. Interesting times ahead!
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