Non Bank Financial Institutions

Published Date: 02 Nov 2017

1.1 Introduction

Non-Bank Financial Institutions play a significant role in meeting the diverse financial needs of various sectors of an economy and thus contribute to the economic development of the country as well as to the deepening of the country’s financial system. According to Goldsmith (1969), financial development in a country starts with the development of banking institutions but as the development process proceeds, NBFIs become prominent alongside the banking sector. Both can play significant roles in influencing and mobilizing savings for investment. Their involvement in the process generally makes them competitors as they endeavour to cater to the same needs. However, they are also complementary to each other as each can develop its own niche, and thus may venture into an area where the other may not, which ultimately strengthens the financial mobility of both, Ahmed et al. (2007).

With the changing needs and tough competition with the banks, the performance of the NBFIs should be analysed. To analyse the performance of the NBFIs, two companies from the NBDTIs have been assessed by the tools of the financial statement analysis such as Ratio Analysis and Comparative Financial Statement Analysis. The Ratio Analysis and Comparative Analysis will help in analysing and evaluating trend which a company is following and it will also help to highlight actual or potential problem as well as performance of the two NBDTIs.

Financial Statement Analysis is useful but before going further it should be borne in mind that this analysis does have certain major limitations.

1.1 Layout of the project

Chapter 1: Introduction

It provides an introduction on the NBDTIs and Financial Statement Analysis

Chapter 2: Literature Review

It provides an explanation about financial statement analysis, popular tools of financial statement analysis that can be used to evaluate the performance of a company and the limitations of the financial statement analysis

Chapter 3: Overview

It gives an overview of the Non-Bank Financial Sector in Mauritius

Chapter 4: Industry Analysis

It provides an analysis of the NBDTIs in Mauritius using the Porter’s Five Forces

Chapter 5: Research Methodology

It is about the research methodology of the project. It explained how data are collected and which method are used

Chapter 6: Findings and Analysis

An analysis of the performance of MLCL and FCL using the technique of financial statement analysis such as Ratio Analysis and Comparative Financial Statement Analysis

Chapter 7: Conclusion and Recommendations

Conclusion concludes on the performance of the two companies and the reasons on which the conclusion was based on with some recommendations.

2.1 Financial Statement

Wild et al. (2007), financial statements are the major source of information used by different users to have an understanding about the performance of a company. There are five components of financial statements, namely: balance sheet, income statement, owner’s equity statement, cash flow statement and notes to financial statements.

According to Alfredson et al. (2005), the preparation of financial statements is required to provide information to its users regarding the financial condition, performance and future prospects of a company. They also identified that each financial statement has its own objectives. Balance sheet is prepared to provide information about a company’s financial condition, while income statement is used to provide information about a company’s financial performances. The owner’s equity statement is used to assess the full performance of a company, it includes revenues, expenses, gains or losses that are reported in income statement and also transactions related to equity holders (such as, owner’s investments and withdrawal). Moreover, the statement of owner’s equity acts as a connection between the balance sheet and income statement. Cash flow statement is prepared to support users with the information about the movement of cash (inflows and outflows) in the company. The last statement which is the notes to financial statements contains additional information to improve the understanding of the other four statements mentioned above.

2.2 The Qualitative Characteristics of Accounting Information

To reflect truthfully a company’s financial performance, there are four qualitative characteristics of accounting information, namely:

2.2.1 Relevance

To be useful, financial information should be pertinent to the decision-making needs of financial statement users. Information has the quality of relevance when it influences the economic decisions of financial statement users by helping them evaluate past, present or future events or confirming or rectifying their past evaluations. Information may be considered relevant if it is material that is its omission or misstatement could affect the economic decisions of financial statement users.

2.2.2 Reliability

Lewis and Pendrill (1996), information is said to be "reliable" when it is free from material bias and can be depended upon by users to represent faithfully what it either purports to represent or could reasonably be expected to represent, Ludwig (2004). In view of the inherent difficulties in identifying certain transactions or in finding appropriate methods of measurement or presentation, financial statements cannot be perfectly "accurate", hence realistic representation might be regarded as describing the closest that accountants can come towards the absolute of total accuracy.

Reliability is enhanced when the following principles are observed in the preparation of financial statements:

Substance over form-Transactions should be accounted for according to their substance and economic reality even if their legal form is different.

Neutrality-Information should be objective and free from bias.

Prudence-Reasonable effort should be made to ensure that the position or degree of success of an entity is not overstated, Alexander and Britton (1996).

Completeness-Financial information must be complete, if the information is to be reliable.

2.2.3 Comparability

Comparable financial accounting information permits users to identify real similarities and differences in the entity’s performance in relation to its own performance over time and in relation to the performance of other entities. The usefulness of financial accounting information is, therefore enhanced by the use of similar measurement and/or disclosure methods to similar events. While there is some overlap between comparability, reliability and relevance, the many aspects of comparability are so important in providing useful financial accounting information to users that a separate consideration seems to be warranted.

2.2.4 Consistency

An entity should be consistent in its application of accounting measurement and disclosure methods from one period to another. However, this does not mean that the entity should keep using the same measurement and disclosure methods for the same transaction if there is a genuine reason to use other methods. For example, the management of the entity may decide to change the depreciation method if there were justifications that warrant the use of a different method. However, the change and its effect should be disclosed in the financial statements.

2.3 Financial Statement Analysis

John N. Myres (2012) had defined Financial statement analysis as a study of relationship among the various financial factors in a business, as disclosed by a single set of statements and a study of the trends of these factors, as shown in a series of statements.", Venkatapathy (2012).

Rachchh Minaxi (2011) has suggested that financial statement analysis involves evaluating the financial statements to extract information that can simplify decision making. It is also the process of assessing the relationship between component parts of the financial statements to obtain a better understanding of an entity’s position and performance, Venkatapathy (2012).

A successful financial analysis and planning requires an understanding of a company’s external and internal environments, Baker and Powell (2005). External factors that affect a firm’s profitability may be issues such as inflation, interest rates, exchange rates, and government policy. The firm’s internal environment includes items that can be affected by management, such as organizational structure, employee motivation and productivity, cost control and the company’s plant and operations. For example, sales are affected one way or the other by the state of the economy, management’s ability to handle growth and the quality and marketing of the company’s product. Pricing decisions are also influenced by the state of the economy, actions by competitors, and the firm’s production costs. The joint impact of the external and internal environment on a firm should be reflected in its financial statements. These statements are a good way to assess the success or failure of the company’s strategies and operations.

The purpose of financial analysis is to analyze the information contained in financial statements so as to judge the profitability and financial soundness of the firm. The analysis and interpretation of financial statements is crucial to bring out the mystery behind the figures in financial statements. Financial statement analysis is an endeavor to determine the importance and meaning of the financial statement data so that forecast may be made of the future earnings, ability to pay interest and debt maturities (both current and long term) and profitability of a sound dividend policy. Moreover financial statement analysis additionally helps management in making a comparative study of the profitability of various firms engaged in similar businesses and also in assessing the strength of the business.

Financial statement analysis includes both ‘analysis’ and ‘interpretation’. Therefore a distinction should be made between the two terms. While ‘analysis’ imply the simplification of financial data by methodical classification of the data given in financial statements, ‘interpretation’ means ‘explaining the meaning and significance of the data so simplified’. However, both ‘analysis and interpretation’ are interlinked and complementary to each other. Analysis is useless without interpretation and interpretation without analysis is difficult or even insurmountable.

2.4 Parties interested and significance of financial analysis

Financial analysis can be undertaken by different users. The nature of analysis will differ depending on the purpose of the analyst. A method frequently used by an analyst need not necessarily serve the purpose of other analysts because of the difference in the interests of the analysts. Financial analysis is useful and significant to different users in the following ways:

Top Management

The importance of financial analysis is not limited to the finance manager alone but includes also top management in general and the other functional managers. Management of the firm would be intrigued with every aspect of the financial analysis, as it helps them in preparing budgets, quantifying the success of the company’s operations, appraising the individual’s performance and evaluating the system of internal control. It is the total responsibility of the management to see that the resources of the firm are utilized most efficiently, and that the firm’s financial condition is sound.

Finance Managers

Financial analysis emphasizes on the facts and relationships related to managerial performance, corporate efficiency, financial strengths and weaknesses and soundness of the company. A finance manager must be well-equipped with the different tools of analysis to make rational decisions for the firm as it helps in studying accounting data to determine the continuity of the operating policies, investment value of the business, credit ratings and testing the efficiency of operations. The techniques are equally important in the area of financial control, enabling the finance manager to make constant reviews of the actual financial operations of the firm to evaluate the causes of major deviations, which may help in corrective action wherever indicated.

Investors

Investors, who have invested their money in the firm’s shares, are intrigued with the well-being of the business as they would like to know the earning capacity of the business and its prospects of future growth. As such, they concentrate on the analysis of the firm’s present and future profitability. They are additionally intrigued with the firm’s capital structure to ascertain its influences on firm’s earning and risk.

Trade Creditors

A trade creditor, through an analysis of financial statements, appraises not only the immediate ability of the company to meet its obligations, but also judges the probability of its perpetuated ability to meet all its financial obligations in future. Trade creditors are particularly fascinated with the firm’s ability to meet their claims over a very short period of time. Their analysis will, therefore, confine to the evaluation of the firm’s liquidity position.

Lenders

Suppliers of long-term debt are concerned with the firm’s long- term solvency and survival. They evaluate the firm’s profitability overtime for assessing the company’s ability to generate cash to be able to pay interest and refund the principal .Long-term tenders do analyze the historical financial statements but they place more weight on the firm’s projected financial statements to make analysis about its future solvency and profitability.

Others

The economists, researchers, etc. analyze the financial statements to study the present business and economic conditions. The government agencies need it for price regulations, taxation and other similar purposes.

2.5 Techniques of financial analysis

The following techniques can be used in connection with analysis and interpretation of financial statements:

1. Comparative financial statements Analysis

The comparative financial statements are statements of the financial position at different periods of time. The elements of financial position are shown in a comparative form so as to give a conception of financial position at two or more periods. The statements of two or more periods are prepared to show absolute data of two or more years, increases or decreases in absolute data in value and in terms of percentages. The two comparative statements are:

Comparative Balance Sheet- the comparative balance sheet analysis is the study of the trend of the same items, group of items and computed items in two or more balance sheets of the same business enterprise on different dates.

Comparative Income Statement- the comparative income statement gives the results of the operations of a business. It gives an idea of the progress of a business over a period of time.

2. Trend percentage analysis

Trend analysis is an important tool of horizontal financial analysis. This analysis enables to know the changes in the financial function and operating efficiency between the time period chosen. By studying the trends of each item we can know the direction of changes and based upon the direction of changes, the opinions can be formed. The trend ratios may be compared with industry in order to know the strong or weak points of a concern.

3. Common size statement

Common size financial statements are those in which figures reported are converted to some common base. Vertical analysis is required for an interpretation of underlying causes of changes over a period of time. For this, items in the financial statements are presented as percentages or ratios to total of the items and a common base for comparison is provided. Common size statements may be used for:

Common Size Balance Sheet- a statement in which balance sheet items are expressed as the ratio of each asset to total assets and the ratio of each liability is expressed as a ratio of total liabilities.

Common Size Income Statement- the items in income statement can be shown as percentages of sales to show the relation of each item to sales. A significant relationship can be established.

4. Funds Flow Statement (or Analysis)

This statement is prepared in order to reveal clearly the various sources from where the funds are procured to finance the activities of a business concern during the accounting period and also highlight the uses to which these funds are put during the said period.

5. Cash Flow Statement (or Analysis)

This statement is prepared to know clearly the various items of inflow and outflow of cash. It is an essential instrument for short-term financial analysis and is helpful in the evaluation of current liquidity of a business concern. It helps the business executives of a business in the efficient cash management and internal financial management.

6. Ratio Analysis

Ratio analysis is the systematic use of ratios to interpret financial statements so that the existing strengths and weaknesses of a firm can be determined and it also provides information about the historical performance and current financial condition of a particular firm. The ratios can be classified into the following types:

Liquidity Ratio

Profitability Ratio

Activity Ratio

Leverage Ratio

2.6 Limitation of Financial Statement Analysis

Although analysis of financial statement is essential to obtain relevant information for making several decisions and formulating corporate plans and policies, it should be carefully performed as it suffers from a number of the following limitations:

Differences in accounting methods between companies sometimes make comparisons difficult.

The precision of financial information largely depends on how accurately financial statements are prepared. If their preparation is erroneous, the information obtained from their analysis will also be wrong which may mislead the user in making decisions.

Since financial statements are prepared by using historical financial data, therefore, the information derived from such statements may not be effective in corporate planning, if the previous situation does not prevail.

Then financial statement analysis provides only quantitative information about the company's financial affairs. However, it fails to provide qualitative information such as management labour relation, customer's satisfaction, and management’s skills which are also equally important for decision making.

The financial statements are predicted on historical data. Therefore comparative analysis of financial statements of different years cannot be done as inflation distorts the view presented by the statements of different years.

The skills used in the analysis without adequate knowledge of the subject matter may lead to negative direction. Similarly, biased attitude of the analyst may additionally lead to erroneous judgment and conclusion.

2.7 Empirical Evidence

Kainth (2008) reports that "Financial intermediaries like Non-Banking Financial Companies constitute a significant element of the financial system and have penetrated into those areas where banks did not dare by taking both the operational and regulatory risks". He had based his study upon secondary data collected from various issues of Reserve Bank of India Bulletin and Report on Trend and Progress of Banking in India.

Amita Kantawala (2001), conclude that there exists a significant difference in the profitability ratios, leverage ratios and liquidity ratios of various categories of NBFCs such as trading in shares and investment holdings, hire purchase finance, loan finance and leasing. She also concludes that the ratios for all categories of NBFCs are generally different from each other.

Seema (1995), studied the financial performance of 10 leasing companies at the disaggregate level and compared it with other groups of NBFCs for a period of 5 years from 1985-90. Her study being limited to only 10 companies did not reflect the correct status of performance of NBFCs on the whole.

Suresh Vadde (2011), analyses the performance of 1,211 non-government financial and investment companies (other than banking, insurance and chit-fund companies) during the year 2008-2009. He had used profitability ratios, liabilities structure and asset structure to evaluate the 1,211 companies. . He had observed from the consolidated results of the selected 1,211 non-government financial and investment companies that growth in income decelerated during the year 2008-2009. Moreover growth in total expenditure also decelerated which was higher than the income growth. The growth in expenditure was mainly driven by the growth in interest payments. As a result, operating profits of the selected companies declined.

Ahmad et al. (2011) evaluated the financial performance of those non-bank finance companies which are providing the services of investment advisory (IAS), asset management (AMS), leasing and investment finance (IF) for two years (2008-2009). They have used ratio analysis to analyze the financial performance of non-bank financial institutions. Their study concluded that the financial performance of non-bank financial institutions was better in 2008 as compared to the overall decline in 2009 caused by many factors such as increase in discount rate, unstable economic conditions, less confidence of investors on non-bank financial institutions, capital market conditions and high reliance on the borrowings from other institutions with high cost of acquiring debt.

Subina Syal and Menka Goswani (2012), assessed the financial performance and growth of the non-banking financial institutions in India for the last five years from 2007-2011. Their study presents a comparable data for the preceding five years based on the analysis of the companies’ accounts for the respective years. They had observed that the overall performance of the non-bank financial institutions was showing a favorable trend in the working of the non-bank financial institutions, which had emphasized the important role they are playing in the growth and development of India. They had also observed that the growth of non-bank financial institutions was mainly due to their strength over the banks because of their effective customer orientation that was a result of the tailor made services they provide to their clients, the speedy and simplified service procedures adopted by them and high rate of interests on their deposits. Also the NBFIs are not under the strict regulations as are imposed on the banking institutions, which provide them greater flexibility.

Shah-Noor Rahman and Tazrina Farah (2012) explored the indicators of the firms in the Non-Banking Financial Institutions industry of Bangladesh. They have pointed out that liquidity is considered as one of the most prominent yardstick of performance measurement of financial institutions. Investors generally perceive the financial institutions to be superior over the others if it has sufficient liquid or current assets. So when an NBFI has enough liquidity the investors feel more secured and approach these NBFI for their investment. The more the number of customers increases the more it becomes profitable. Thus the analysis indicates that liquidity position exerts more influence on profitability. Again they see operating revenue is the another variable which has a major impact on net profit as per their study. So it is undoubtedly true that if the revenue increases, ultimately it has a positive effect over the profitability.

Alam et al. (2011) suggested to allow the leasing companies to execute the business of land and residential apartments and buildings so that they can earn better profit and enable the small entrepreneur with financing and that there should be only one regulatory body for leasing companies and banking sector so that the products and services could be different from each other. Moreover some restrictions can be applied on banks or leasing companies regarding products and services if the banks and leasing companies want to offer the same line of products and services. Their study also focused on examining the financial performance of leasing companies since 2008 to 2010 using ratio analysis and they found that in 2010 the financial ratios were showing positive change but there was a decline in financial performance of leasing companies in 2009 as compared to 2008.

Saleha et al. (2012) scrutinized the financial performance of leasing sector of Pakistan during the last 10 years (2001 to 2010). On the basis of ratio analysis, their study concludes that there had been an overall decline in the performance of NBFCs due to the increase in discount rate, unstable economic conditions and less confidence of investors.

Xiaoqiang Cheng and Hans Degryse (2009) provided evidence on the relationship between finance and growth in a fast growing country like China by employing data of 27 Chinese provinces over the period 1995-2003. They had studied whether the financial development of two different types of financial institutions (banks and non-banks) have a (significantly different) impact on local economic growth. They had found that banking development has a statistically significant and economically more pronounced impact on local economic growth than non-bank.

Nehal Ahmed and Mainul Islam Chowdhury (2007) found that though the major business of most NBFIs is leasing some are also diversifying into other lines of business like term lending, housing finance, merchant banking, equity financing and venture capital financing. They had also used the performance ratios such as current ratio, debt-equity ratio, productivity ratio and return on equity as a measure of liquidity, risk coverage, operational efficiency and profitability, respectively. An important role which NBFI’s play in an economy is to act as a buffer, especially in the moments of economic distress. An efficient NBFI sector also acts as a systemic risk mitigator and contributes to the overall goal of financial stability in the economy.

Since Gerschenkron (1962) classic study emphasized the role of the banking systems in the economic development of Germany, France and Italy in the nineteenth century, it may appear that the need for a non-bank financial sector is largely redundant in the specific circumstances of the developing economies. However, there are two main reasons why the existence of Non-Bank Financial Institutions (NBFIs) matters: one concerns economic development and the other relates to financial stability, Fadzlan Sufian (2006).

Hossain et al. (2005), Commercial banks by their definition are unsuited for long term lending. Inefficiency of Bank Financial Institutions in long-term loan management has already leaded a massive volume of outstanding loan in our economy. However, with the present status, expertise and efficiency, the Non Commercial Banks are barely able to serve the future investment demand of the country. Private commercial banks are less experienced and less equipped in this regard and they would not take the load or be able to take future challenges of term lending of the country. Therefore in order to ensure flow of term loans and to meet the credit gap, development of NBFIs is a compelling necessity for the economy.

M.R. Shollapur (2010) recognized that NBFCs in India have attached a considerable importance to safety and security of their funds as well as the long-term growth of their customers. NBFCs in India have tried to be distinct by offering personalized services as well as improving service quality. They have adopted comprehensive techniques such as opinion survey of existing customers and formal market research for eliciting ideas on innovative products. NBFCs perceive price as an index of image as well as a technique of product differentiation. The NBFCs believe in raising funds at lower costs so as to achieve cost effectiveness in their operations. The reduction in interest rates in the economy as a whole will help NBFCs to access the resources at low costs.

Shariq Nisar and Mohsin Aziz (2004) concluded that India’s decision to introduce large-scale regulatory changes in the non-banking financial sector at a time when most of the South Asian countries were passing through severe economic recession did not predict well for the non-banking finance sector. So Islamic NBFCs appears to have suffered more because of the distinct nature of their business and other religious constraints like not being able to avail the conventional avenues available to other financial institutions. In a fast changing regulatory environment like this, a conventional NBFC would prefer keeping its money in commercial banks than to go with risk associated ventures that are part and parcel of Islamic financial institutions.

Al Amin (2011), Inefficiency of Bank Financial Institutions in long-term loan management has already leaded a huge volume of outstanding loan in our country. At this backdrop, in order to confirm flow of term loans and to meet the credit gap, NBFIs have immense importance in the economy. In addition, non-bank financial sector is important to increment the mobilization of term savings and for the sake of providing support services to the capital market.

Ofoeda et al. (2012) have shown that there is a negative relationship between minimum capital adequacy requirement and risks weighted assets of NBFIs along with a positive relationship between regulatory pressure and risk weighted assets of NBFIs. They had also reported a negative relationship between restrictions on deposits and the risk of insolvency. In other word non-deposit-taking NBFIs have higher weighted assets and are prone to the risk of insolvency than deposit-taking NBFIs.

Bhargavi (2004), reported that with the present changing economic scenario wherein liberalization, privatization and globalization is on and restrictions and regulations has been removed, under this conditions, the performance of Non-banking Financial Companies engaged in leasing business do struggle for existence and the "survival of the fittest" is the policy. Only the strongest NBFCs with good capital base, huge net worth and valuable brand image could survive in the country