Why Risk Management is the Key to the Survival of NBFCs

While a few NBFCs exhibited robust growth, most disruptive and conservative NBFCs weren’t left unscathed by the current downtime. And though the government has created reforms and policies to get NBFCs back on track, the road ahead is neither short nor smooth, making it important to strengthen their risk management frameworks. Risk management impacts NBFCs' potential to attract and raise funds from primary markets in the short run and enlist on the stock exchange further down the line. Financial institutions can no longer afford to sit back and wait for yet another disaster to strike but must proactively identify and mitigate both internal and external risks.

An ASSOCHAM report that was released shortly after the liquidity crisis of 2018 identified the key risks faced by NBFCs and the risk management techniques to manage liquidity and avoid insolvency:

Credit risk
A Credit Risk for Indian Corporates report in 2015 found that though the average default risk of Indian organizations has improved since 2008, their risks have also remained higher than those of other Asian, US, and European firms. The management of credit risk involves setting up standards and policies for operating procedures that are reviewed regularly. To mitigate this risk, NBFCs require a robust system of credit line management for various transactions, including over-withdrawals, loan approvals, account inactivity, etc. These measures must also be audited internally to ensure that the company stays on track.

Vendor risk
The vendor risk management market size is expected to grow from USD 3.29 Billion in 2017 to USD 6.50 Billion by 2022. Outsourcing activities such as data entry, documentation, and field verification to third-party vendors leaves NBFCs open to a plethora of risks. To minimize their exposure, the vendors they deal with must be carefully selected through an unbiased system that considers the service provider’s operating model and qualifications to meet their needs. These services must also be supervised and audited to ensure quality, with penalties for failing to meet service levels.

Compliance reviews
The recent influx caused by the NBFC crisis and regulations set for NBFCs has made conducting compliance reviews compulsory. Companies should create a comprehensive framework that ensures adherence to the guidelines at all times.

Quality control
Apart from the above risk management techniques, quality controls must also be carried out to ensure that the functions of non-banking financial institutions are in line with the standardized stipulated processes.

Information and data integrity
Financial institutions have access to a significant volume of confidential customer data, which needs to be secured against leaks. Data breaches of any kind could affect the finances of customers and, in turn, the reputation of the NBFC. Cybersecurity is key to maintaining the integrity of the data and the company.

They often say lightning never strikes the same spot twice, but the IL&FS crisis seemed to have sent the NBFC sector into a downward spiral with no foreseeable end. What started as a default by one company resulted in a domino effect that adversely affected the NBFC sector and, in turn, led to a decline in GDP growth. If effective risk management models and processes are implemented in the NBFC sector, inadequacies can be detected and rectified before escalating into a crisis.

As one such NBFC, Capri Global assesses the risks posed and has countermeasures in play to overcome them. We firmly believe that traditional financing needs to be reoriented for the informal sector while leveraging technology to foster trust and transparency that helps us serve customers better.

Our field-based credit assessment with robust risk controls enables us to evaluate risks and ensure adherence to stringent standards of governance and regulatory requirements. Our branch network allows us to take a relationship-driven approach with each customer at a local level. This helps us arrive at an optimal home finance requirement, speed up disbursal, and ensure regular and disciplined collections.