“Modelling determinants of financial performance

of non-banking finance companies in India”

A DISSERTATION PROJECT REPORT SUBMITTED

IN THE PARTIAL FULFILMENT OF THE REQUIREMENTS OF

ARKA JAIN UNIVERSITY

For the award of the degree of

BACHELOR OF COMMERCE (HONORS)

For the session 2021-2024

Submitted By
Name: SUSHANT KUMAR
University Enrolment Number: AJU/211339

Faculty Mentor
Name: Prof. SEEMA DAS
Designation: ASSISTANT PROFESSOR
School of Commerce and Management, ARKA JAIN UNIVERSITY
 DECLARATION BY THE STUDENT

I, SUSHANT KUMAR, hereby declare the dissertation report titled “Modelling

determinants of financial performance of non-banking finance companies
in India”, is hereby submitted in the partial fulfilment of the requirement of ARKA JAIN
UNIVERSITY for the award of the degree of Bachelor of Commerce.

To the best of my knowledge, the project undertaken, has been carried out by me and is my original
work. The contents of this report are authentic, and this report has been submitted to ARKA JAIN
UNIVERSITY and it has not been submitted elsewhere for the award of any Certificate/ Degree/
Diploma etc.

Name of the Student: SUSHANT KUMAR

Signature of the Student

University Enrolment No.: AJU/211339

B.COM (H) (2021- 2024)
 CERTIFICATE OF APPROVAL

This Dissertation Report of “SUSHANT KUMAR” titled “Modelling

determinants of
financial performance of non-banking finance companies in India”,
is approved in quality and form and has been found to be fit for the Partial Fulfilment of the
requirements of ARKA JAIN UNIVERSITY for the award of the degree of Bachelor of
Commerce.

Approval of the Program Coordinator Approval of the Assistant Dean (UG)

Department of B. Com (H) School of Commerce and Management
School of Commerce and Management ARKA JAIN UNIVERSITY
ARKA JAIN UNIVERSITY

APPROVAL OF THE EXAMINER

 CERTIFICATE BY THE FACULTY MEMBER

This is to certify that SUSHANT KUMAR, of ARKA JAIN UNIVERSITY, AJU/211339, a

student of BCom (H) (2021-2024), has undertaken Dissertation Report Title titled
“Modelling determinants of financial performance of non-banking
finance companies in India”, for the partial fulfilment of the requirement of ARKA
JAIN UNIVERSITY for the award of the degree of Bachelor of Commerce, under my
supervision.

Signature of the Faculty Mentor,

Name of the Faculty Mentor: Prof. SEEMA DAS
Designation of the Faculty Mentor: ASSISTANT PROFESSOR
 ACKNOWLEDGEMENT

I take this opportunity to thank my faculty mentor Prof. SEEMA DAS school of
COMMERCE AND MANAGEMENT, ARKA JAIN UNIVERSITY, for her
valuable guidance, closely supervising this work over with helpful suggestions, which helped
me to complete the report properly and present.
More importantly, her valuable advice and support helped me to put some creative efforts on
my project. She has really been an inspiration and driving force for me has constantly
enriched my row ideas with her vast experience and knowledge.

Specially, I would also like to give my special thanks to my parents whose blessings and love
enabled me to complete this work properly as well.

Name of the Student: SUSHANT KUMAR

University Enrolment No.: AJU/211339
B. Com (2021-2024)
 INDEX
CHAPTER NO. CHAPTER NAME PAGE NO.

Executive Summary
Chapter 1.
Chapter 2. Review of Literature
Chapter 3. Research Methodology
Chapter 4. Data Analysis
Chapter 5. Findings
Chapter 6. Suggestions
Chapter 7. Conclusion
Chapter 8. References
Chapter 9. Bibliography
 EXECUTIVE SUMMARY

A study was conducted based on modelling of financial performance of top

performing NBFCs in India. The study considers 8 financial variables of
concerned companies. The study’s sample size consists of 10 non-banking
financial companies having significant asset size across India. The study has been
prepared using 5 years of data. So, the dataset is both cross-sectional and time-
series data. The mathematical modelling, statistical inferences have been drawn
using SPSS.
The financial performance gets reflected in the profitability of the firm and thus
this study entails modelling of profitability and finding its relationship with
different financial parameters. Traditionally Return on Asset and Return on Net
Worth have been taken as measure of profitability in different studies. But here,
besides modelling profitability with ROA as measure of profitability, in another
case Net Profitability Margin has been chosen as the proxy for measuring
profitability in accordance with CRISIL‟s methodology of ranking NBFCs; an
approach completely focused on NBFCs in India as regulatory environment vary
a lot in different economies and thus measures of performance can vary.
Profitability equation has been modelled using different financial parameters
which are a part of CAMEL approach concerning asset quality, liquidity,
operating efficiency, credit costs, earnings of the companies to result into
development of a robust financial performance model. The models have been
tested for multi-collinearity, hetero-semanticity and auto-correlation
The implications from the statistical inferences have also been documented in the
report. The study shows the relationship between the dependent variables and
independent variables and its business implications. This helps in interpreting the
behaviour of financial variables and establishes a meaningful connection with
operational activities.
 INTRODUCTION
NBFC sector is undergoing through a landmark shift due to tightening regulatory
norms and expanding business portfolios of the companies. The new guidelines
propose that all NBFCs, whether deposit taking or not, are mandatorily required
to maintain Tier l capital at 10% vs. 7.5% required to be maintained presently
while the norms for overall capital adequacy ratio have been kept unchanged at
15%.It would be an interesting situation to see how the profitability of the these
financial companies would get affected by the new capital requirements of the
companies. Thus, it is very important in present context to come up with a model
to express true relationship between profitability and its determinants.

The NBFC sector is facing the dual heat of increasing credit costs and elevated
funding costs in current times; however, credit rating companies like CRISIL and
ICRA have been doing stress tests on the asset quality, capital provisions and
funding costs of top performing NBFCs which show that the efficient and safe
level of pre-provision operating profit gives a strong cushion against upcoming
credit quality issues. Cost of funds for firms continue to sustain on the higher
level as the pie of bank funding in the overall borrowings of NBFCs remains be
high along with the high levels of bank base rates during financial year 2013.
Furthermore, the cost of funding in future years of would be significantly
influenced by the RBI guidelines on the funds that can be raised by NBFCs
through private issue of debentures. According to industry estimates, private
placements with retail investors form close to 6.5% of entire borrowings. On the
contrary the pie for individual NBFCs can go as high as 50% of borrowings; in
such a scenario funding cost of these firms could get elevated in future by 4-50
bps as NBFCs would bring in policies to replace their retail fund mobilization
from the private route to the more expensive bank borrowing/ public issue route
depending upon the company’s share of retail private issues and the amount of
outstanding retail private issue debentures. Credit costs is a major determinant of
long-term profitability of a company and impacts in a big way. It’s of utmost
importance to decipher how increasing credit costs can impact the profitability of
the top NBFCs.
Post financial crisis of 2008, drastic changes in economic environment has led to
acute pressure on asset quality of the companies. Non-performing loans have shot
up putting pressure on the profitability. Especially, the difficult operating
economic environment around the heavy and medium commercial vehicle and
construction equipment segments will be keeping a quality of the asset under
huge pressure. The light commercial vehicles segment which has grown its share
aggressively in recent years across regions is also likely to face moderate to high
asset quality issues in its business portfolio.
Another important part of the discussion is impact of RBI‟s tightening of rules
on financial performance of NBFCs that lend against gold .To keep check on the
aggressive growth of gold loan providing NBFCs, RBI first took strict measures
in 2011 and removed the priority sector status it had provided them since a long
time under which they can receive loans advanced by banks to them for further
lending the money against gold .
 LITERATURE REVIEW

 Khandoker, Raul and Rahman, conducted a study which established a

relationship between independent variables as; Net shareholders worth,
Total liability, Total asset, and Operating revenue and dependent variable
as; Net Profit. It was observed that the company’s liquidity, leverage and
operational efficiency has a major bearing on Profitability of Non-Bank
financial companies in Bangladesh. While Net profit has a positive and
significant relationship with Total Assets, Total Liability, Net shareholders
worth & Operating Revenue; it enjoyed negative relationship with Term
deposits and operating expenses. From the study the independent variables
combined could explain 98.3 % variation in value of Net profit which has
been taken as the measure of profitability. Operating revenue had the
highest impact on profitability and Net worth had least impact on
profitability.

 Nibedita Roy (2013) in her paper evaluated the performance and financial
health of the financial institutions, more specifically gold. The empirical
findings of the study were very crucial in wake of upsurge in the volume
of gold loan among organized sector players viz. banks and Non-Banking
Financial Companies (NBFCs). Accordingly, the findings of the study have
determined out that the companies have higher level of debt in their capital
structure than required as optimum, aggressive, and risky lending policy,
lower level of liquidity, decreasing NNPA ratio and increasing trend of
capital risk weighted asset ratio. The author has used global method of
CAMELS rating to identify dependent and independent variables which
measure financial performance based on earnings, management capacity,
Liquidity, Capital Adequacy and Asset quality of the firm. Profit after Tax
has been found to be significantly and positively related to Advances to
assets, Liquid assets to total assets. On the contrary PAT has found to be in
negative relationship with majority of the variables viz. Debt Equity ratio,
NNPA, Investments to Assets ratio, Gsecs to Total Investments ratio.
Capital adequacy ratio has improved across years based on directives of
RBI while NNPAs have decreased showing a marked improvement in
quality of assets of companies. The loans and advances portfolios of the
 companies have seen a sharp hike over the years as evident from advances
to borrowings and advances to assets ratio. Companies have not done a
very great job in terms of increase in liquid assets with respect to total
assets in the portfolio which brings in a level of financial risk into the
system. Companies have been using high leverage to run their businesses
which has eaten down the profits and have thus led to reduced profitability.
Spreads of firms have seen no major variations and thus companies with
lower spreads and High advance to borrowing ratio should be cautious of
the financial decisions that they make as it might adversely impact the
profitability.

 Alam, Raza & Akram (2011) examined the financial performance of asset
leasing companies from 2008-10. The number of leasing companies are
gradually going down in recent years on account of decreasing profitability
and slow business. The factors attributable to decreasing profits are due to
the high provisioning cost, ever increasing discount rate, high operating
expenses, uncertain economic conditions, political anarchy, high
competition with banks and other financial companies and high
dependence on borrowing from other institutions. Researchers suggested
to allow the leasing companies to expand business in real estate segment
to enhance profitability. A single regulatory body was suggested to exist in
place of multiple bodies for leasing companies and banking sector

 Kantawala (2011) examined the financial performance of different groups

of NBFCs Separately because of business model of different categories of
NBFCs differ along with the operating environment and market dynamics.
It was concluded from the study that profitability, liquidity, and leverage
ratios bear a significant difference depending on the NBFC category for
which they are being measured. Four categories of NBFCs have been
considered in the study viz. Leasing, Loan finance, Hire purchase, Trading,
and investment companies. From the analysis of the study, it was inferred
that that Gross profit to Total income ratio, Profit before Tax to Total
Income ratio, Profit after Tax to Asset ratio and Retained earnings to Profit
after Tax ratios have come out to be maximum for the Trading and
investment holding companies. Dividend to Profit after Tax and Tax to
Profit after Tax ratios are maximum for Loan companies showing lowest
Retained profit to Profit before Tax ratio for loan companies. Interest
 coverage ratio and Profit after Tax to Net worth are found to be maximum
for Hire purchase companies. Total income to Total assets has been found
to be maximum for asset leasing companies. Amongst the leverage ratios
Borrowings to Total assets, Debt to Total assets, Debt to Net worth is
maximum for Hire Purchase companies closely followed by asset leasing
companies due to a relatively higher threshold of level of permissible
deposits that can be taken. Bank borrowing to assets and Bank Borrowing
to Total borrowing came out to be highest for leasing companies whereas
net worth to total assets has found to be maximum for trading and
Investment holding Companies

 Suresh Vadde (2011) evaluated the financial and organizational

performance of private financial and investment companies (excluding
insurance and banking companies) during the year 200809.The post
analysis results showed that growth in both main income and other income,
went down during the year. Though on the other side, growth in total
expenditure also decreased, still it was at higher level than the income
growth. The major reason for the growth in expenditure was attributed to
the growth in interest payments. Following, operating profits of the studied
companies went down along with the decreasing profitability. A huge
chunk of funds raised during this financial year was in form of borrowings.
Other major share of funds was acquired by raising new fresh capital from
the capital market. Majority of the funds raised during the year were put as
advances and investments in the credit market. However, its ratio in total
applications of funds went down.

 Syal & Goswami (2011) analysed financial performance and growth of the
non-banking financial institutions in India in the last 5 years which was
insightful for the potential investors to get the knowledge about the
financial performance of the non-banking financial institutions and be
helpful in taking effective long-term investment decisions. The growth of
NBFCs has been mainly due to their advantage over the commercial banks
because of their strong customer orientation and connect which is
inherently a result of the customer oriented and customized services they
provide to their clients, fast and simplified service policies adopted by them
and relatively high rate of interests on the term and other deposits.
 RESEARCH METHODOLOGY
The research is empirical in nature. The data of 10 topmost listed NBFCs of India
in terms of asset size were selected for 5 years (2009-2013). The reason for
selection for 5 years’ time span was that one business cycle is completed in 5-6
years. The reason to select these 10 companies were manyfold. Firstly, NBFC
market in India is still very concentrated and these top 10 companies combined
have a major share in total asset size of all listed players in India. Secondly, these
10 companies are truly representative of separate NBFC types of companies
whether it be gold loan, asset financing, leasing,vehicle financing or others. Vast
and mix of business portfolios of the sample companies make it representative of
effects that can happen on NBFC market either due to economic conditions or
market specific reasons.Thirdly,getting all the data required for the empirical
analysis was a major obstacle too as number of listed NBFCs in India is still very
less and getting their financial data is also a major The data for this study was
collected from different sources like from the Bloomberg terminal, audited
financial results published by the l10 companies. Further, other sources like
research reports, journals, financial newspapers, and websites, etc. were
considered whenever found necessary. Hence the data is totally transparent in
context of authenticity. SPSS software was used for data analysis.
A detail of these companies is given below:

COMPANY TOTAL ASSETS (Rs MARKET CAP (Rs

Mn) Mn)

Shriram Transport 539057 1,30,253

IDFC LTD 535330 1,69,210

M&M Financial Services 270708 146372

IFCI LTD 245980 39970

SREI Infra 226591 9181

Cholmondeley Finance 215707 31365

Bajaj Finance 203207 58330

Sundaram Finance 158227 55975

Shriram City 155886 63201

Magma Fincorp 50963 12051

THEORETICAL FRAMEWORK
Model 1:
To investigate the six variables identified in this study associated with the impact
on Net Profitability Margin of top ten listed NBFCs, this study undertook an
empirical testing of a model with the following framework:

Net Profitability Margin = f (Cost to income ratio, Net Interest Margin, Gross
Nonperforming asset ratio, Capital risk weighted asset ratio, Return on equity,
Debt equity ratio)

NPM = β0 + β1NIM + β2CI + β3 GNPA + β4CRAR + β5ROE + β6 DE where

NPM= net profitability margin
NIM= net interest margin
CI= cost to income ratio
GNPA=Gross Nonperforming asset
CRAR=Capital risk weighted asset ratio
ROE= Return on equity
DE= Debt equity ratio
The above model tests the following null hypothesis “there is no significant
impact of the factors upon the profitability.

Dependent Variable
Net Profitability Margin
Net profit margin is the percentage of revenue remaining after all operating
expenses, interest, taxes and preferred stock dividends (but not common stock
dividends) have been reduced from a company's total revenue. Post financial
crisis of 2008 as regulatory concerns have deepened over NBFC functions and
supervision, credit rating companies like CRISIL have come up with the
concept of core profitability measured by Net Profitability Margin . CRISIL
believes that the NPM is a better measure of profitability than traditional
indicators such as return on asset.

Independent variables

1. Cost to Income Ratio:

Cost to income ratio is defined as non interest cost, excluding bad debt expenses,
divided by the total of net interest income and noninterest income. Although the
ratio is related to both cost and income, the focus of the ratio is more on the cost
side. Non interest costs are seen as those shares of a banks costs which can be
controlled. The reason cost to income ratio does not contain bad and doubtful debt
expense is because such an expense generally shows the quality of financial
decisions made in earlier periods rather than current performance of bank. And
this ratio would be severely disturbed in case major write offs are done.

2. Capital Risk Weighted Asset Ratio:

CRAR is the measure of firm capitalization and is a ratio of NBFCs Tier1+Tier2
capital to risk adjusted assets. This ratio below a minimum threshold indicates
that the bank is not suitably capitalized to expand its operations and portfolio and
should take necessary steps to capitalize itself as directed by RBI mandatory
regulations
CAR = Tier I capital + Tier II capital / Risk weighted assets
Tier I Capital includes paid-up equity capital, statutory reserves, capital reserves,
and perpetual debt instruments eligible. Tier II capital is classified as secondary
capital which includes undisclosed reserves, loss reserves, subordinated term debt,
etc.

3.Gross Non-Performing Asset (%):

The gross NPA to loans ratio is considered as a measure of the asset quality and
gives a look into company's loan portfolio. An NPA are the assets for which
interest has not been paid for more than 180 days (or 6 months). Higher ratio
shows increasing bad quality of loans are present in the portfolio

4.Net Interest Margin:

Net Interest margin is an important measuring performance metric that evaluates
the success of a firm’s investment decisions as opposed to its debt structure of the
company. A negative Net Interest Margin depicts that the firm failed to take
optimal financial decision, as interest expenses were greater than the returns
generated by investments.
Net Interest Margin is the ratio of net interest income to average interest-earning
assets Where, Net interest income is the difference between interest income and
interest expense. Average Interest-earning assets are loans / advances given to
borrowers and investors by NBFCs. Average of the beginning to end of the period
is considered for exact calculation.
5.Return on Equity:
This ratio indicates profitability of a company by comparing its net profit to its
average shareholders' equity. ROE measures how much the stockholders and
investors earned on their investment in the company. The higher is the return on
shareholders’ equity, the more efficiently management is operating and utilizing
its equity in the company.
6.Debt to equity ratio:
A measure of a company's financial leverage found out by dividing its total
liabilities by average shareholders' equity. It indicates the level of equity and debt
the company is using to finance its assets or in short, the level of financial
leverage company is resorting to run its business. A high debt/equity ratio usually
means that a firm has been very much aggressive in financing its operations and
growth with debt. This might bring in a factor of financial risk as earnings could
become volatile because of the excessive interest expense

Model 2:
To investigate the six variables identified in this study associated with the impact
on Return on Asset of top ten listed NBFCs, this study undertook an empirical
testing of a model with the following framework:

Return on Asset = f (Cost to income ratio, Net Interest Margin, Gross Non
performing asset ratio, Capital risk weighted asset ratio, Return on equity, Debt
equity ratio)

ROA = β0 + β1NIM + β2CI + β3 GNPA + β4CRAR + β5ROE + β6 DE where

ROA=Return on Asset
NIM= net interest margin
CI= cost to income ratio
GNPA=Gross Non performing asset
CRAR=Capital risk weighted asset ratio
ROE= Return on equity
DE= Debt equity ratio
The above model tests the following null hypothesis “there is no significant
impact of the factors upon the profitability.

Dependent Variable
Return on Asset
This ratio indicates how profitable a firm is with respect to its total asset base.
The return on assets (ROA) ratio shows the capacity of the management in
employing the company's total assets to realize high profits. The higher the
return on assets, the more efficiently company’s management is utilizing its
asset base.
Independent variables
1. Cost to Income Ratio:
Cost to income ratio is defined as non interest cost, excluding bad debt expenses,
divided by the total of net interest income and non-interest income. Although the
ratio is related to both cost and income, the focus of the ratio is more on the cost
side. Non interest costs are seen as those shares of a banks costs which can be
controlled. The reason cost to income ratio does not contain bad and doubtful debt
expense is because such an expense generally shows the quality of financial
decisions made in earlier periods rather than current performance of bank. And
this ratio would be severely disturbed in case major write offs are done.

2. Capital Risk Weighted Asset Ratio:

CRAR is the measure of firm capitalization and is a ratio of NBFCs Tier1+Tier2
capital to risk adjusted assets. This ratio Of course! Please provide me with the
text selection you would like me to fix for grammar and spelling, and I'll be happy
to help you. Of course! Please provide me with the text selection you would like
me to fix for grammar and spelling, and I'll be happy to help you. Of course!
Please provide me with the text selection you would like me to fix for grammar
and spelling, and I'll be happy to help you. Below a minimum threshold indicates
that the bank is not suitably capitalized to expand its operations and portfolio and
should take necessary steps to capitalize itself as directed by RBI mandatory
regulations
CAR = Tier I capital + Tier II capital / Risk weighted assets
Tier I Capital includes paid-up equity capital, statutory reserves, capital reserves,
and perpetual debt instruments eligible. Tier II capital is classified as secondary
capital which includes undisclosed reserves, loss reserves, subordinated term debt,
etc.

3.Gross Non-Performing Asset (%):

The gross NPA to loans ratio is considered as a measure of the asset quality and
gives a look into company's loan portfolio. An NPA are the assets for which
interest has not been paid for more than 180 days (or 6 months).Higher ratio
shows increasing bad quality of loans are present in the portfolio

4.Net Interest Margin:

Net Interest margin is an important measuring performance metric that evaluates
the success of a firm’s investment decisions as opposed to its debt structure of the
company. A negative Net
Interest Margin depicts that the firm failed to take optimal financial decision, as
interest expenses were greater than the returns generated by investments.
Net Interest Margin is the ratio of net interest income to average interest-earning
assets Where, Net interest income is the difference between interest income and
interest expense. Average Interest-earning assets are loans / advances given to
borrowers and investors by NBFCs. Average of the beginning to end of the period
is considered for exact calculation.
5.Return on Equity:
This ratio indicates profitability of a company by comparing its net profit to its
average shareholders' equity. ROE measures how much the stockholders and
investors earned on their investment in the company. The higher is the return on
shareholders’ equity, the more efficiently management is operating and utilizing
its equity in the company.
6.Debt to equity ratio:
A measure of a company's financial leverage found out by dividing its total
liabilities by average shareholders' equity. It indicates the level of equity and debt
the company is using to finance its assets or in short the level of financial leverage
company is resorting to run its business. A high debt/equity ratio usually means
that a firm has been very much aggressive in financing its operations and growth
with debt. This might bring in a factor of financial risk as earnings could become
volatile as a result of the excessive interest expense .