5 performance metrics every NBFC should track
Non-banking finance companies (NBFCs) form an integral
part of the Indian financial system. They play an important role by
complementing the banking sector in reaching out credit to the unbanked
segments of society, especially to the micro, small and medium enterprises
(MSMEs), which form the base of entrepreneurship and innovation. The role of
NBFCs becomes even more important now, especially when the government has a
strong focus on promoting entrepreneurship so that India can emerge as a
country of job creators instead of being one of job seekers.
The NBFC sector in India has undergone a significant
transformation over the past few years. The success of NBFCs can be clearly
attributed to their better product lines, lower cost, wider and effective
reach, strong risk management capabilities to check and control bad debts, and
better understanding of their customer segments.
NBFCs are certainly emerging as better alternatives to
the conventional banks for meeting the financial needs of various sectors.
However, to survive and to constantly grow, NBFCs have to focus on their core
strengths while improving on weaknesses. They will have to be very dynamic and
constantly endeavour to search for new products and services in order to
survive in this ever-competitive financial market.
Evaluating NBFCs is a different ballgame altogether as
NBFCs are different from manufacturing companies. There is no single metric for
evaluation, you have to look at a combination. Traditionally people have used
the following metrics to value NBFCs.
1. Return on Assets
(RoA) v/s Return on Equity (RoE):
RoA ratio tells you how efficient the NBFC is in its operations & fund
raising. The higher the RoA, the better, though it can depend on the asset
class. RoE tells you how well the NBFC generates a return on share holder’s
equity. The higher the better. This can be compared across different asset
classes. Above 20% is considered to be really good.
2. Price to Book
(P/B): Simply put it is the
ratio of market cap to its book value (shareholder’s equity). This ratio tells
you how expensively or cheaply it's valued by the market. Lower P/B might mean
that the NBFC is undervalued. This needs to be looked at in conjunction with
RoA and RoE.
3. Spread: This is the difference between the NBFC’s average
lending rate and its cost of funds. This could be higher because of its assets
class or due to management’s ability to raise funds at a lower cost. Higher the
operating cost, lower the spread.
4. OPEX & Growth
in AUM: Operating Expenses (OPEX)
as a % of AUM tells you how well managed & efficient NBFC’s operations are.
At the end of the day every business needs to grow for its value to appreciate.
This growth rate can be compared with other companies. Anything above 15% is
considered very good.
5. Gross NPAs: This tells you how well managed the loan book is.
More specifically, how robust are the NBFC’s lending criteria and how tight are
its loan recovery mechanisms. Though it's not fair to compare across asset
classes, this should be as low as possible. Anything around 1% is considered
good.
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