The rise of NBFCs in the Digital Age

NFCs have become a vital source of funding for a large portion of the population, including micro, small, and medium-sized enterprises (MSMEs) and those who are economically underserved and unserved. They have successfully met the diverse needs of borrowers quickly and efficiently, taking into account their extensive geographical reach and understanding of people’s various financial needs. Moreover, non-bank moneylenders have significantly promoted financial inclusion by supporting the growth of millions of MSMEs and self- employed individuals.

In 2023, NBFCs contributed 12.60% to India’s gross domestic product (GDP) and held nearly 30% of the country’s total non-food credit market share. Over the past five years, NBFCs’ market share has consistently grown, encroaching on banks’ market share. NBFCs have introduced innovative products to meet the specific needs of different customer segments, offering niche product offerings.

Credit facilitation frameworks such as Account Aggregator (AA), Open Credit Enablement Network (OCEN), and Open Network for Digital Commerce (ONDC) are promoting new lending methods. Additionally, digitization has enabled seamless processing and frictionless customer experiences. Data democratization and emerging technologies like artificial intelligence (AI), analytics, and early warning systems (EWS) further enhance operations throughout the lending value chain, including sourcing, onboarding, credit underwriting, monitoring, and collections. FinTech companies and digital platforms have expanded access to credit by partnering with various NBFCs. Furthermore, FinTech firms are now seeking to transition from customer engagement platforms to NBFCs, with several FinTech companies recently applying for NBFC licenses from regulators.

The Government and Reserve Bank of India (RBI) have implemented a range of measures such as Mudra Loans, Trade Receivables electronic Discounting System (TreDS), Account Aggregators, and ONDC to promote and bolster the development of small businesses. Additional regulatory frameworks like co-lending and First Loss Default Guarantee (FLDG) have facilitated partnerships between NBFCs, FinTech organizations, and banks, enabling them to offer increased credit options to various customer segments. To align its regulatory framework with the changing risk profiles of NBFCs, the RBI introduced a regulation in October 2021 that considers the size of NBFCs. This regulatory adjustment aims to enhance the classification of these financial entities based on their evolving risk profiles, considering factors such as their expanding scale, growing complexity, and increasing interconnectedness within the financial industry.

Key trends in the NBFC sector

The Indian NBFC sector is rapidly transforming across four key areas. Firstly, digital adoption is increasing, leveraging AI and blockchain for operational efficiency and innovative product offerings via mobile and online platforms.

Secondly, NBFCs are diversifying, expanding portfolios, forming partnerships and prioritising customer needs. Thirdly, digital infrastructure is helping reach underserved customers, fostering financial inclusion. Lastly, regulations are tightening to ensure compliance, digital processes and consumer protection, reflecting the sector’s adaptation to digitalisation and evolving regulations for sustained growth.

NBFCs unleashing potential through digital adoption

With digital transformation across NBFCs, they are increasingly focusing on paperless customer acquisition/onboarding, digital underwriting, disbursements and collections and technology- led product innovations.

Customer acquisition and onboarding: Many NBFCs are now adopting digital journeys for their customer acquisition and onboarding processes. A large upper-layer NBFC has developed an end-to-end paperless journey in rural group loans, two-wheeler finance, farm equipment finance and personal loans.

Super apps and segment-specific digital assets: NBFCs are building super apps to list all their financial services offerings under one roof.

NBFCs are also developing separate segment-specific digital assets to run lending programmes. One of India’s biggest NBFCs has launched a cashflow-backed digital MSME lending platform that uses traditional and alternate data sources along with value-added services to manage and grow the MSME ecosystem’s business.

Mobile apps and online platforms: NBFCs are gradually prioritising the development of user-friendly mobile apps and online platforms to provide convenient access to financial services. A large NBFC has acquired many users and runs multiple in-app programmes for its customers.

Automation, AI and chatbots in operations: NBFCs are automating various aspects of their operations, including loan underwriting, risk assessment and customer service. Furthermore, they are building multilingual chatbots to enhance customer experience and service.

Also Read | Next Gen NBFCs: A Vital Force In Shaping India’s 2047 Vision

Data analytics for insights: Leveraging data analytics tools, NBFCs are gaining valuable insights into customer behaviour, market trends and credit risk profiles. Doing so enables them to develop targeted marketing strategies, assess creditworthiness more accurately and optimise business processes for better efficiency.

Cloud and cybersecurity: Cloud adoption in NBFCs is rising, enabling scalable infrastructure and enhanced operational efficiency. However, there is also a heightened focus on cybersecurity measures to mitigate risks associated with
data breaches and ensure robust protection of customers and sensitive financial information.

New business models are driving the rise of NBFCs

Numerous obstacles exist in traditional working models at NBFCs, including high operational costs associated with personnel and branches, extended lead generation and processing times, outdated technologies, and inadequate data governance. These have severely constrained NBFCs’ ability to grow their businesses overall.

To spur corporate growth, NBFCs keep up with the times by progressively implementing several initiatives throughout the value chain.

Some of these have been discussed below:

• Marketplace model: NBFCs are now moving beyond offering their own traditional financial services products to building marketplaces of financial
  services that provide payments, insurance, cards, investments and deposits – in addition to loan products – all under one platform. They are partnering with other banks and financial institutions to offer multiple options to customers – for e.g. a large upper-layer NBFC has created a marketplace, which is a one-stop digital platform offering financial products across all categories like loans, cards, insurance, investments, payments, pocket insurance and value-added services (VAS).
• Co-lending: NBFCs are now embracing the co-lending set-up, wherein banks and NBFCs collaborate to facilitate the joint contribution of credit for priority sector lending. Co-lending is meant to enable risk sharing and facilitate seamlessness between current account–savings account (CASA) funded balance sheets to NBFCs (banks bring the cost of fund advantage, and NBFCs bring efficient last-mile reach with asset class specialisation).
• Embedded finance: Embedded finance is a way to provide customers with access to credit via non-financial entities by embedding lending capabilities in them. In these cases, the entity providing credit will be a bank or an NBFC, although the channel to get credit will be a non- financial entity. New modes and channels of lending, like OCEN and ONDC, will help boost embedded finance.
• Diversification of product portfolio: NBFCs are now focusing on creating hyper-personalised financial products to cater to the evolving needs of their customers. Many are launching products in affordable housing finance in their retail portfolio. Moreover, for MSMEs they have introduced supply chain finance (SCF), a key offering to address the working capital needs of MSMEs. With the introduction of TreDS, participation of NBFCs has become significantly easier. However, running one’s own SCF programme in collaboration with SCF platforms will enable NBFCs to access a larger pool of MSMEs. This technology system will help with risk assessment as well. In the absence of credit history, AI-enabled risk assessment solutions will help NBFCs to evaluate borrowers’ creditworthiness and expected business growth.
• Partnerships and collaboration: NBFCs have strategic alliances with FinTech start-ups to leverage their technological expertise and customer reach. These partnerships often involve joint product development, sharing of data analytics capabilities and accessing new distribution channels. Some NBFCs are forming joint ventures with banks and/ or other financial institutions to combine strengths and offer a range of financial services offerings. These partnerships can enhance credibility, expand market presence and mitigate risks.

The path to a resilient future for NBFCs hinges on innovative business models accelerated technology adoption and robust governance practices. Embracing agile strategies and collaborative partnerships fosters innovation while leveraging cutting- edge technologies to enhance competitiveness. These approaches, coupled with transparent governance frameworks, empower NBFCs to navigate challenges effectively and thrive in an ever-evolving financial landscape.

Also Read | NBFCs’ Stronghold: The Factors Behind Their Consistent Market Share Amid Bank Competition

As we move into the second half of the decade, NBFCs in India are poised for a remarkable transformation. NBFCs are anticipated to undergo significant transformations across various fronts, including technology, business models, partnerships, governance, risk, compliance and talent resilience. This evolution is not only driven by internal factors but also by the changing dynamics of the financial market in India.

Views expressed by Alok Aggarwal, Chief Executive Officer, Muthoot Homefin