Final Year Dissertation Report FMS MBA F PDF

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Final Year Dissertation Report

FINAL YEAR DISSERTATION “Modeling

determinants of financial performance of Non

Banking finance companies in India”

A project report submitted in partial fulfilment of the requirements for the degree of Master of Business Administration (Full time) from FMS, DELHI.

Submitted by: Abhishek Kumar Singh FMS MBA(FT), Batch of 2014 Roll no: F-77 Date: 21/03/2014

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Under guidance of: Dr. Pankaj Sinha Faculty of Management Studies University of Delhi

Final Year Dissertation Report

Table of Contents

CERTIFICATE .................................................................................................................................................. 3 ACKNOWLEDGEMENT ................................................................................................................................... 4 EXECUTIVE SUMMARY .................................................................................................................................. 5 RATIONALE OF THE STUDY............................................................................................................................ 6 INTRODUCTION............................................................................................................................................. 7 LITERATURE REVIEW ..................................................................................................................................... 8 DATA & METHODOLOGY................................................................................ Error! Bookmark not defined. Data ......................................................................................................................................................... 10 Econometric Methodology ..................................................................................................................... 11 Theoretical Framework ........................................................................................................................... 13 Model 1 ........................................................................................................................................... 13 Model 2 .......................................................................................................................................... 16 EMPIRICAL FINDINGS AND RESULTS ........................................................................................................... 19 Multiple Regression Model: Model 1 .....................................................................................................19 Multiple Regression Model: Model 2 .....................................................................................................25 CONCLUSION............................................................................................................................................... 31 BIBLIOGRAPHY ............................................................................................................................................ 32 APPENDICES ................................................................................................................................................ 33 Financial Data Excel................................................................................................................................. 33 Bloomberg data ......................................................................................................................................35

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Final Year Dissertation Report

CERTIFICATE

This is to certify that the Project Report titled “Modeling determinants of financial performance of Non Banking finance companies in India” is based on my original work conducted under the guidance of Dr.Pankaj Sinha and no part of this work has been copied from any other source. Material wherever borrowed has been duly acknowledged.

Dated:21.03.2014

Dr.Pankaj Sinha (Project Guide) Faculty Of Management Studies University Of Delhi

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Abhishek Kumar Singh FMS MBA(FT), 2012-14 Roll No: F-077

Final Year Dissertation Report

ACKNOWLEDGEMENT

First and foremost, I‟d like to thank my guide Dr. Pankaj Sinha, for providing me with an opportunity to work under him through the medium of this research project. He has been instrumental in my being able to complete this project to the best of my capabilities.

I would also take this opportunity to express my gratitude and thank all other individuals who have been kind enough to spare their precious time in sharing insights with me, which has facilitated in making this project a more fruitful outcome. A special mention to acknowledge the assistance provided by some of our esteemed faculty members, my friends, family and industry professionals, for always being available to attend to all my doubts, inhibitions and queries.

A word of thanks also to the administrative staff at FMS, for their perennial support in making available all possible facilities, in turn aiding my research for this project.

Finally, I wish to thank all my colleagues at FMS for their constant support and motivation, which has contributed in making this project a better effort.

Abhishek Kumar Singh FMS MBA(FT), 2012-14 Roll No: F-077

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Final Year Dissertation Report

EXECUTIVE SUMMARY

A study was conducted based on modeling of financial performance of top performing NBFCs in India. The study takes into account 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 modeling, statistical inferences have been drawn using SPSS. The financial performance gets reflected in the profitability of the firm and thus this study entails modeling 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 modeling profitability with ROA as measure of profitability , in an 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 modeled 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 mode l. The models have been tested for multi-collinearity, hetero-skedasticity 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 behavior of financial variables and establishes a meaningful connection with operational activities.

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Final Year Dissertation Report

RATIONALE OF THE STUDY

With ever expanding financial system of the country, Non Banking Financial companies have emerged as the torchbearers of this financial growth and the recent upsurge in the number of registered NBFCs and series of regulatory steps taken by RBI to ensure a stable system has posed an important question. What measures the profitability of these entities and how these variables are connected to the general financial parameters of companies which serve as the barometer of their growth and stability. The present study will discover the factors involved for determination of financial performance of Non Banking Financial companies in India. There has been always a disagreement over which is the better measure of profitability: Return on Asset, Return on Net Worth or Net Profitability margin. Traditionally Return on Asset and Return on Net Worth have been used to measure profitability but with changing market environment and regulatory policies, firms have been changing their financial yardsticks to measure profitability and financial performance. In current scenario, credit rating companies like ICRA are moving towards using Net profitability margin as a core measure of profitability; a better measure than Return on Asset.The study also covers comparative analysis of how ROA depends on its determinants vs how Net profitability margin is related to set of financial parameters. We will be able to find out the level of correlation between parameters and how strongly they change with variations in values. :

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Final Year Dissertation Report 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 companies 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. Its 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 the 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

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Final Year Dissertation Report 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 companies 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 8|P age

Final Year Dissertation Report

Kantawala(2011) examined the financial performance of different groups of NBFCs Separately on account of the fact that 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 depeding 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 are 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 invesments in the credit market. However, its ratio in total applications of funds went down.. Syal & Goswami(2011) analyzed 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.

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Final Year Dissertation Report

DATA

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...