A while ago I used to work in an NBFC that lent money at 18-20% to private schools meant for the urban poor. Schools that charged between 250-500 rupees a month. Their only claim to fame was that they were better than government schools. Effectively , their education too was superficial at best, but people could read basic English and do basic math. Anyway, the company was a start up and I was in charge of creating the loan algorithm and signing off on the loans. We did pretty ok in the first few months, until we found an investor who  pumped in a humongous sum and then started pushing  us to increase the book faster.

We were in a totally unformalised system where our basis for revenue wasn’t balance sheets, but simply running into classrooms and taking a surprise headcount. These loans took time as they were quite intuitive and less based on quantitative factors. Anyway, once we began to hurry up, there was major chaos in the company. Marketing, just started dumping files and credit kept delaying it due to overload. The marketing guys had targets and incentives ! Credit guys like me, had NOTHING ! Quite often I was offered simplistic bribes like a dinner or a drink ( the loans were quite small 5-15 lakhs ). The system broke. Instead of the credit team being on the top of the pyramid, the marketing team took its place. It’s pretty easy to guess that what followed were a string of bad loans, that credit signed off under duress and coercion . Eventually a few people, including me left from the credit team. The company luckily survived due to super human recovery practices, but that is not the point.

Incentives to the marketing team on loan sanction and not on recovery killed the system.

Yearly targets and bonuses on loans that have a tenure of 24-36 months killed the work ethic. When the loans you originate are not your problem to recover, the system in inherently flawed. The power of incentives to the workforce as well as to the promoters have a huge bearing on the future of the company.

Munger puts it real well saying

“Never, ever, think about something else when you should be thinking about the power of incentives.”- Munger

The NBFC mess in India is primarily because of 3 issues

  • Lack of skin in the game of Promoters of NBFC.
  • Incentives that reward on loan origination rather than loan recovery.
  • The main goal shifting from lending well, to growing the book, issuing new equity at lofty  valuation and then looking to become market leaders or selling promoter shares.

Sadly, even when some companies in the system follow these principles, they are painted just the same way as companies that don’t. Take real estate for example, it took forever to be able to segregate the good from the bad. In many ways, it is still work-in-progress, but I see light at the end of the tunnel, at least for urban Indians who purchase in white.

Looks like the same thing will happen in NBFC’s. I think a few consistent quarters despite the current fall should do the trick.

Maybe BFSI should stop bonuses all together and only give out ESOPS !

“If we don’t like the consequences of an action we’ve taken, we’re less likely to do it again; if we do like the consequences, we’re more likely to do it again. Punishment works best to prevent actions, and incentives work best to encourage them.” -Munger.

Sadly, we have been encouraging what needs to be punished and punishing what needs to be encouraged. Time to INVERT, INVERT, INVERT !

help help help

One thought on “An oversimplified explanation of the current NBFC meltdown.

  1. Poorly managed NBFCs would have, of course, growing the loan book as target for the marketing guys and not also for the recovery, these kind of disaster to happen.
    It is akin to where a marketing guy is responsible and have a target for selling a product/service, but, does not have responsibility and target for collecting the outstanding from the trade channel.


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