In Conversation with Bama Balakrishnan, CFA

The lending market in India has grown considerably over the last five years. The market is characterized by the introduction of innovative products, digitization and the entry of new participants. We had an interesting conversation with Bama Balakrishnan, Executive Director and Chief Operating Officer at Northern Arc Capital, who has first-hand experience of the changing trends in the lending market.

Parvez: The lending market in India has evolved over the years. Many new lending institutions have blossomed in the last decade. What is your experience of the changing trends in the lending market?

Bama: The lending market in India has been dominated largely by banks and non-banking financial companies (NBFCs) over the years with a much smaller share of debt financing flowing from capital market investors such as mutual funds, insurance companies, pension funds. They have also been significant investors in the securitisation market. Banks have invested mostly in securitisation instruments that help meet Priority Sector Lending targets with greater allocation towards higher rated originators and/or instruments.

A few interesting trends have emerged especially in retail lending over the last few years. One, we have seen the emergence and scaling of fintech delivery models with digital sourcing, underwriting basis digital data and electronic payments being leveraged for disbursements and collections across MSME and consumer financing. Two, we have seen the growth of embedded finance, more so in consumer finance, where the delivery of financial services is bundled with the purchase of a product or service – both in online and offline channels. Some of this has been fuelled by the explosion in ecommerce and digital delivery of services especially with the impact of the Covid-19 pandemic.

Three, we have seen the emergence of partnerships between banks and NBFCs as well as fintech platforms, enabling the flow of credit to underserved, harder to reach customer segments including MSMEs and households, closing some of the gaps in credit depth.

Bond markets have traditionally seen limited primary and secondary appetite especially for issuances rated below AA+. There was temporarily greater participation by banks in lower rated bonds issued by NBFCs with partial guarantees pursuant to certain regulatory measures announced after the onset of the Covid-19 pandemic. There is otherwise a very limited set of investors who participate in structured debt instruments including credit enhanced bonds. Over the last two years, we have seen private wealth and retail investors making higher allocations to fixed income instruments seeking higher yields given significantly lower returns on traditional products such as bank deposits. Interestingly, we have also seen the emergence of digital platforms that facilitate direct investment in debt at lower ticket sizes – enabling access to retail investors for such instruments which were hitherto only accessed by HNIs and family offices. It remains to be seen how this allocation shifts as we go through a rising interest rate cycle.

Over the last few years more Alternative Investment Funds investing in debt have emerged, some with specialized strategies such as venture debt, meeting gaps in the market. We have also seen the emergence of debt PMS offerings that offer more tailored strategies to investors.

Parvez: Micro, Small and Medium Enterprises (MSMEs) contribute significantly to economic growth. Has digitization in lending led to democratization of credit for MSMEs? Is there improvement in transparency and better credit risk management?

Bama: The June 2019 Report of the Expert Committee on Micro, Small and Medium Enterprises established by the Reserve Bank of India estimated that the total credit gap in the MSME sector is INR 20-25 trillion. While much progress has been made, clearly much more remains to be done. Over the last few years, we have seen a revolution in the access to finance for MSMEs from banks and NBFCs. Firstly, we have seen the emergence of both phygital and fintech platforms that provide unsecured business loans to MSMEs supporting their working capital requirements. There is also a cohort of supply chain financing programmes and platforms including multiple trade receivables discounting platforms that have extended the reach of credit to lower tier suppliers and dealers of smaller SMEs, who are not served by banks and large NBFCs. We have also seen the emergence of embedded finance on B2B platforms that support procurement of products and services by MSMEs.

These trends have been supported by easier access to banking and GST data as well as greater adoption of UPI based payments providing a bigger digital footprint of the business performance of the MSME. Affordable Housing Finance Companies also extend secured financing to self-employed customers meeting their business needs. These business models have taken a long time to scale, constrained by traditional business models of largely brick and mortar origination and underwriting as well as lesser penetration of digital collections.

Bank partnerships have emerged as an interesting source of financing for MSMEs via the NBFCs and fintech platforms, supporting the flow of credit.  The RBI notification in May 2022 permitting the inclusion of bank lending to NBFCs for on-lending to MSMEs as part of priority sector lending on an on-going basis is an important catalyst for the stable flow of financing to MSMEs.

A key challenge in deepening access to credit for the MSME sector continues to be higher cost of financing due to the higher cost of delivery of credit and higher credit costs – due to higher vulnerability of MSMEs to credit cycles, event risks, such as the pandemic. The growth of ecosystems such as the Open Credit Enablement Network could be disruptors in catalysing access to finance for MSMEs – by democratizing the infrastructure required for greater participation in these credit markets at lower cost of origination and underwriting.

Parvez: Securitization has been an attractive option for banks and NBFCs as it provides various benefits including portfolio diversification, improved liquidity and cost efficiency. What are the challenges you see in structuring and pricing of the securitized deals given the uncertain economic environment?

Bama: The risk appetite for investing in securitised debt as well as the availability of eligible portfolio reduced in the wake of the Covid-19 pandemic. Starting Q3 FY22, asset quality indicators on rated securitisation pools such as collection efficiencies showed stability and some improvement and were relatively less impacted by the third wave of the pandemic, as reported by leading rating agencies. Investors preferred securitisation as opposed to direct assignment, given the benefit of credit enhancement in the structure to absorb losses from the pool allowing for better rating of the senior instruments. Rating agencies expect annual securitisation volumes in FY23 to witness 20%-30% increase over FY22.

Investors evaluating securitised debt now have a few considerations to bear in mind – one, deeper analysis of the performance of originator portfolios by segment such as restructured loans, post Covid origination etc. and two, building in nuanced expectations of the impact of higher inflation and interest rates on the credit performance of portfolios, especially vehicle finance loans and assessing the sufficiency of credit enhancement and structures to address potential volatility in collections basis the uncertain macro environment. Structural innovations such as floating rate instruments may be built into securitisation structures to protect longer tenure instruments in a rising interest rate environment.

Parvez: ESG framework has become pervasive. Issuers need to incorporate ESG factors if they are to attract investors. In the absence of any set standards, how can investors ensure that the investments are ESG compliant, especially esoteric transactions like securitization?

Bama: At this time, domestic investors are guided more by requirements such as priority sector lending or portfolio diversification and their risk return requirements rather than ESG in particular while impact investors especially offshore investors and DFIs use fairly stringent ESG guidelines at an issuer and portfolio level. We see this changing significantly domestically as well with leading listed entities issuing integrated reports covering ESG reporting as well as many entities publishing impact studies. We have also seen leading financial institutions issue impact bonds to raise financing including from offshore markets.

A few mechanisms that we have observed investors use – a comprehensive ESG assessment framework/tool, detailed ongoing reporting on entity and portfolio level reporting on ESG norms and milestones-based tracking of commitments to improve the level of ESG compliance. The role of specialists in each of these aspects has become quite crucial both for issuers / originators and investors/lenders.

Parvez: You have vast experience in the finance domain donning many different roles in your career. Please share a snippet of your journey as a guide for young professionals.

Bama: A few trends that I observe and that young professionals must prepare themselves for – the role of technology in the design and delivery of financial services has only accelerated – today, financial services businesses are increasingly digital first. Accordingly, building a greater all-round understanding and experience in the design and delivery of digital financial services is becoming essential. Secondly, experience in multiple domains and functions, preferably in multiple international markets is crucial to growth into leadership roles especially as there remain fewer specialist careers in financial services. One must not be afraid to get on a new S curve as one succeeds in their current role. Thirdly, the world today is about ecosystems and partnerships. This creates new opportunities and challenges and requires a broader understanding of the market to navigate successfully.

About Bama Balakrishnan

Bama Balakrishnan is the Executive Director and Chief Operating Officer of Northern Arc Capital. She currently oversees the Financial Institutions, Mid-Market Origination Business and Markets Distribution for Northern Arc. She has also served previously as the Chief Financial Officer and Chief Risk Officer of the company. In her role as chief financial officer, she played a key role in deepening access to liabilities and completing a significant capital raise for our Company. Prior to joining Northern Arc, she worked with ICICI Bank for 10 years. She is a director on the board of Dvara Research Foundation, an organization engaged in research and policy advocacy. She holds a bachelor’s degree in commerce from the University of Madras, a post-graduate diploma in management from the Indian Institute of Management, Ahmedabad and a professional diploma in software technology and systems management from the National Institute of Information Technology. She is also a member of the Institute of Cost and Works Accountants of India and a CFA charterholder.

About Parvez Abbas, CFA

Parvez Abbas is working as an Assistant Director in the Lending Services division at Acuity Knowledge Partners. He has more than 13 years of experience spanning across investment research, credit solutions and structured products. He has served clients including global banks and asset managers providing assistance in securitization, credit risk management and portfolio analytics. In the past, Parvez has worked for Cians Analytics, Genpact and American Express. He is an MBA finance and a CFA charterholder.