Indian two thousand and five hundred rupee banknotes are arranged for a photograph in Mumbai, India (Photographer: Dhiraj Singh/Bloomberg)

IIFL’s Nirmal Jain Says 25-30% Growth Not Difficult For NBFCs

Private sector banks and non-banking financial companies that are established and can raise capital are expected to meet the huge credit demand in the economy as public sector lenders struggle for funds, according to Nirmal Jain, founder and chairman of IIFL Holdings Ltd.

“PSU banks are also growing and competing in retail. But in the middle to long term, they are still crippled for capital,” he told BloombergQuint in an interaction. The demand for credit, however, is such that a large part of that will go to the private sector lenders and NBFCs, Jain said, adding that a 25-30 percent growth for non-bank lenders is not difficult.

Jain’s word comes amid the financial services firm’s move to demerge its finance, wealth and capital business into three separate entities. The demerger, followed by listing, will involve three units—IIFL Finance (loans and mortgages); IIFL Wealth (wealth and asset management); and IIFL Securities (capital markets).

Jain is also bullish about the prospects of the wealth business in India.

Given a platform that it has built over the years, IIFL will be able to leverage the opportunity from growth in wealth business in the country, he said.

Jain said the asset management business has the potential to grow at the fastest pace in the next 10 years. But doesn’t believe that maximum gains will only be made by the top five players. “There is enough scope for boutique asset management players to build a niche for themselves.”

Shares of IIFL Holdings rose as much as 3.1 percent intraday to Rs 709 apiece.

Watch the full conversation here

Here’s an edited transcript of the interaction

Where are you on the demerger process?

We have got approval from most of the foreign regulators and the Reserve Bank of India. We are awaiting approval from the Securities and Exchange Board of India. As soon as we receive SEBI’s approval, we can approach the National Company Law Tribunal. Then we can hold shareholders’ and creditors’ meeting. So, the process can take about four to six months.

Would you believe that the natural course of the three businesses getting listed separately will immediately create some value unlocking and then better discovery of valuation multiples over the next few years?

I won’t speculate that there would be any value discovery. In fact, that’s not the objective. Historically, most promoters have tried keep a control through a convoluted structure of subsidiaries and associate companies. We thought about it and realised that the world is changing. The media regulators are looking at the companies which have a clean and transparent structure.

Your economic ownership should mirror the control rather than anything else. If you have the control with majority shareholders together then there’s a merit. That means the structure is evolving.

Also, the regulators are different for three companies. The businesses are distinct in terms of culture and people they cater to. In our model, we have tried to incentivise people with equity. So, the top management better be incentivised by the businesses they are driving and not by equity of a conglomerate and there should be visibility about listing of the companies that they are managing. These are the key drivers. The balance sheet, too, becomes simpler. So, whatever leverage you take also gets content in three separate entities. At the time of listing, Venkat and I will remain the promoters of three entities. Karan Bhagat and Yatin Shah will join as promoters of IIFL wealth.

When you raised funding for the wealth business, IIFL’s shareholding in the combined firm was about 51 odd percent. Do you think it will stay that way closer to listing? Or do you have any plans for fundraising in any of the businesses?

We don’t have any fundraising plan till the listing of the three entities as there is no need of it.

Typically, you need fund for NBFCs. We have an NBFC in wealth and we have another one—Retail NBFC. In Retail NBFC, we raised money from CDC worth $150 million about less than two years ago. That money should be enough for the next 12-24 months. Therefore, fundraising is unlikely until listing.

Let’s talk about value creation.

We aren’t concerned about value creation in the short-term. The market capitalisation at which the companies list bothers me the least. What matters is that these three businesses can be simplified, and they can grow faster. That’s the theme of our annual report.

If they grow faster in a more sustainable way, then you will create lot more value for shareholders over a period of time. In two to five years, these three businesses together should create more value than what the aggregate company could have created otherwise.

Can you tell us about the three businesses? Let’s start with NBFC. The common parlance is that the runway of growth is so great that 25-30 percent, depending on the aggression of the management, should not be a problem for the next five years, if not more. Where are you in this argument?

The company which is going to get listed as an NBFC business has two subsidiaries—the housing finance and microfinance. So, our business is housing finance, microfinance and certain lending. In all these businesses the common element is that we focus on retail lending, small ticket lending and digital delivery.

We are seeing that a lot of progress has been made in technology and digital delivery, data analytics and artificial intelligence which should help reduce the operating cost, improve quality of credit and still reduce cost.

So, there is a great opportunity because this is at the bottom of the pyramid where we talk about microfinance; there is a lot of income-generating activity—a small entrepreneur or people who borrow Rs 5,000-25,000. Then if you look at our SME business in NBFC where the ticket size is Rs 4-5 lakh, again we are talking about small shopkeepers, hawkers. That’s where India has to grow rapidly.

Almost 80 percent of employment is generated from the informal sector and they need capital. They are starved of capital because the banking system couldn’t do the credit assessment or reach out to them. They don’t have income documents or an advisor. But now, with technology and last-mile connectivity, NBFCs like us can reach out to them.

The over-arching theme of our NBFC business is small ticket and digital delivery. If you look at housing loans business, our average ticket size is just Rs 20 lakh. So, typically we are funding houses of less than Rs 25 lakh in terms of value. We are looking at houses in small towns, small cities or suburbs where ticket size is small; the end user is buying the house and he is going to repay out of his income or savings. This is a model that we want to focus on.

Would this mean that there will be growth at a reasonable risk? Typically, in the erstwhile days, housing finance to a salaried employee there is this consistency of income and therefore easy to predict; with the end user not necessarily being a salaried person, if that’s indeed the case, the entail of risk being slightly higher, will companies following this model be able to grow at a great pace and at the same time managing the risks of delinquency in a big way?

It is a myth that salaried class will have a higher risk compared to say, self-employed. At the end of the day if the business goes into recessionary cycle; if the business suffer, even a salaried person can lose his job. What is important is how good is your credit assessment. It’s all about how much you learn, how you use data, the kind of people you have on board who do these jobs, what kind of culture you have in an organisation. Your sales have to separated from the credit policy and underwriting. Say, if sales are trying to achieve numbers and compromise on credit, then there’s a risk. The risk isn’t function of the segment that you service but a lot more depends on your policies, people and culture. That’s where we have invested in the past 10 years.

Would you be happy growing at about 20-25 percent in loan book with slightly a higher proportion of risk because you are relatively speaking younger as compared to some of the others or would you not compromise on the risk aspect at all even if it comes at the cost of growth?

In NBFC or any credit to lending business, if you take undue risk, then there is a sure recipe for suicide. At the same time, I don’t think that any business can be done without taking any risk. If you want to take no risk, then you should not lend to anybody.

When you do a small ticket loan, your loans are dispersed. So, no one borrower can shake the house and you can get warnings signals much faster. You have 30, 60, 90-day buckets. You should have experienced people with the background of understanding retail credit for several years; so, they have seen the cycles…Between growth and risk, risk can never be compromised.

But at the same time, you have to define your appetite for risk. Within that appetite for risk, we would like to grow. But if there’s no opportunity then let the growth slow down as there’s no question of taking risk beyond your appetite.

Would you want to grow the book at 20-25 percent sustainably for the next five-to-seven years?

I think 20-25 percent growth is not difficult for NBFCs. The economy in nominal terms will grow at 12-13 percent and M3 will also grow at 13-14 percent. Credit growth in a fast-growing economy is faster. It can be on a compound average for 10 years anywhere between 15 percent and 20 percent. Now, the public sector banks are crippled for capital. They are also growing and competing in retail but in the middle to long term, they are struggling for funds. They will grow at certain rate but the demand for credit is so huge that most part of it go to private sector banks and NBFCs that are established and can raise capital. I think the whole sector can grow at this pace and if you are slightly better and try to grow a little faster, 20-25 percent growth is not difficult to achieve.

Let’s talk about interest rate hikes.

The cost of funds may not go beyond 25-50 basis points from whatever rates we are talking about because of oil prices—one of the key variables that affect directly or indirectly. The liquidity tightening which we have seen in April-May has eased slightly but still interest rates are going north. Now, in most of the businesses, say small-ticket ones, a 25-50-basis point increase can be absorbed. Even in the mortgage business, small affordable segment, this is okay. But if interest rate goes beyond this, then mortgage market can slow down. But these are part of cycles you have to be prepared for. My personal view is that, if you talk about 5-10-year horizon, then I think Indian currency will do well and interest rate will also come down. The real interest rate can’t sustain more than 2 percent. India’s inflation will lead to global inflation because more or less the economy is open. So, we aren’t looking at a scenario where such high interest rates will sustain over very long time. It’s very unlikely. It may be a question of few quarters or a few months, we have to bear with it. As of now, despite interest rate, the momentum of the economy is so strong that we see credit demand completely unabated.

Let’s talk about the wealth management space.

In our wealth business, we have got a talented and motivated team. There’s a model that we have worked on wealth management. The industry has done well. So, we were there in the right time, at right place with right people and made sure that we follow right practices. This business is very susceptible to people succumbing to short term measures of maximising revenue and dilute the customer relationship over long term. That’s what we are trying to refrain from. The wealth effect in India is just coming into play and what we are seeing is the number of entrepreneurs are able to divest their companies partly or fully to be able to raise wealth and managed professionally. There’s a lot of old wealth that has still not come under the fold of professional management, there are number of individual advisers who account for the large part of the wealth management still in India. They are getting affiliated to or joining the larger firms. The prospect for this industry is very good. But unlike NBFC or credit, it is unprecedented. We don’t know the track record of this business for a very long period. But at this point, it looks like that a lot of new wealth will be created in India. We are in a sweet spot of having built people, practices, policies, systems and ability to deliver. And even brand name, which has been primarily by word of mouth, that if the industry grows, then we should leverage this opportunity. We are also backed by high-quality investors in this business which again is a vote of confidence and credibility.