Valuing the money factories of India.
How to look inside an NBFC and judge its real safety before investing.
In late 2018, a retired schoolteacher in Pune went to his bank to withdraw his fixed deposit. The clerk told him to wait. Outside, news channels were screaming about a giant finance company failing. Suddenly, safe investments did not feel safe anymore.
An NBFC is simply a money factory. Unlike a normal factory that buys steel to make cars, a finance company borrows money to lend it to others. They make their profit on the difference between their borrowing cost and lending rate.
Because they do not have physical factories, their biggest asset is their loan book. If you buy shares in them, you are buying a portion of these loans. If borrowers pay back on time, you win.
But there is a catch. Finance companies operate on high leverage. They use a small amount of their own money and a large amount of borrowed money. This makes them highly fragile when things go wrong.
Two shopkeepers and their loans
Think of two shopkeepers. The first runs a grocery store using his own savings, borrowing nothing. If sales drop by half, he earns less but his shop survives. The second shopkeeper borrows ₹9 for every ₹1 of his own to expand. When times are good, his profits multiply. But if just a few customers fail to pay him back, he cannot pay his lenders and his shop shuts down overnight.
Why this matters
When you buy a finance company, you are not buying physical factories, land, or machinery. You are buying trust and underwriting skill. Understanding how they manage their borrowings and bad loans ensures you do not lose your hard-earned savings when the credit cycle inevitably turns and defaults rise.
Where people go wrong
- Valuing NBFCs using P/E ratio instead of P/BVThe price-to-book ratio is the primary tool because their assets are financial, not physical, and book value reflects the loan book quality.
- Ignoring Asset Liability Management mismatchesBorrowing short-term funds to give long-term loans can lead to sudden liquidity defaults during rate spikes, as seen in the IL&FS crisis in 2018.
- Chasing high RoE driven by dangerous leverageHigh leverage magnifies profits in boom times but can wipe out the company's equity if bad loans rise even slightly.
P/BV is the primary tool because NBFC assets are financial, not physical.
Check the CRAR to ensure the company has a safety buffer above 15%.
Avoid companies that borrow short to lend long, which creates liquidity risks.
Investors chase high-yielding NBFCs during economic booms, forgetting that aggressive lending hides bad loans until the cycle turns.