Introduction

In 1961, the Non-Banking Finance Companies (NBFCs) in India were brought into loose yet legalized regulatory framework from largely unregulated framework. The regulation of these institutions was found to be necessary for ensuring efficacy of credit and monetary policy, safeguarding depositors’ interests and ensuring healthy growth of this sector (Vasudev 1998). The government constituted various committees to suggest the regulatory framework for the non-banking financial sector. The Bhabatosh Datta Study Group (1971), James Raj Study Group (1975), Chakravarthy Committee (1987) and Narashimham Committee (1991) were the important committees to suggest transformation of unregulated non-banking financial sector into regulated one. The inherent strengths of NBFCs such as high-level customer contact and satisfaction, geographical proximity, strong recovery mechanism were the drivers of their performance. Higher rates of interest on deposits offered by them afforded better opportunity of channelizing domestic savings into the financial markets (Ingres 2005). NBFCs had, practically, not been subjected to entry barriers, limitations on fixed assets and holding inventories in the form of gilt investments as they are now (Thiyagarajan, Arulraj 2005). Moreover, the NBFCs are in a consolidation phase now.

As the financial stability was threatened with many of the NBFCs offering unimaginable rates of interest of public deposits, their financial viability was adversely affected because of unrestricted lending even in the case of group exposure. The Narashimam committee on banking sector reforms (Narashimam 1991) suggested the guidelines for banking system should be extended to bring the non-banking finance companies within the ambit of an effective regulatory framework. Khanna Committee (Khanna P.R.1997) and Vasudev Committee (Vasudev 1998) have recommended exclusive regulatory framework for these companies such as mandatory registration, capital adequacy, linking of net owned funds to deposits and application of prudential asset classification and income recognition norms. Non-Banking Financial Companies are reclassified broadly as Asset Finance Companies, Loan Companies and Investment Companies (Reserve Bank 2006).

With the application of the tighter regulations through Reserve Bank of India Directions 1998 (applicable to NBFCs); the advantages enjoyed by NBFCs vis-à-vis banks have eroded (Khan M.Y 2002). The purpose of the paper is to focus on the trends in funds mobilization and to identify the relationships among various types of funds and profitability of Asset Finance Companies (AFC, Equipment and Leasing NBFCs). Further from the literature, it is discernible that the NBFCs have started feeling the heat in the form of increased competition. In order to ward off the competition, they have been resorting to innovation in lending, diversification and exploration of new markets. From various studies published by the Reserve Bank of India (RBI), it is clear that the regulations have affected the financial strength of non-banking finance sector with many smaller finance companies have wound up their activities or merged with viable non-bank finance companies. Kim and Santomero (1988) and Kendall and Levonian (1992) have examined how the design of risk-based capital standards influences bank risk taking. Risk taking behavior influences the strategies to fund assets of banks, long-term costly funds are mobilized when profitability through high cost earning assets are in product mix. Public deposits are the easy yet costly source of financing to meet lending requirements.

Hence, the paper focuses on the key sources of funds and the mediating role played by short-term funds. The authors feel that it is necessary to develop a sound model to identify the mediational role played by short-term funds. In the succeeding sections, the paper will present the emerging trends in funds mobilization, the data, methodology employed, and finally structural equation model to capture mediating effects.

II Literature Review

A FUNDS MOBILIZATION STRATEGIES

Capital management refers to balancing the level of capital in such a manner that growth of assets and liabilities is sustainable without eroding public confidence or profitability. Sinkey (1992) uses Hempel and Yawitz’s (1977) framework to arrive at a similar conceptual framework. The bank’s primary objective of maximizing shareholders’ wealth is depicted as being shaped by owners’ preferences, management’s attitudes and decisions, and society; also listed are six policy strategies to achieve that objective. Management’s attitudes and decisions, the regulatory and economic environment, and the objective of maximizing investors’ wealth (shareholders), in turn, influence these policies. The success of these policy strategies depends on the riskiness of a bank’s balance sheet, that is, the nature of assets and the concentration of loan portfolios (Sinkey 1992). The primary objective of the board is to increase the realizable value of the equity whether on liquidation or through trading. The market value is conditioned by many factors viz., endogenous factors, namely, management attitudes, strategies, long-term business prospects and quality of assets and exogenous factors such as political, socio-economic environment and/or external shocks, therefore is subject to volatility (Kantawala 2004). According to Harker and Zenios (1998), financial performance of an institution – observable but non-actionable – can be affected by its performance along the axis of service delivery and financial intermediation. They concluded that the drivers of performance can be classified into, strategy, execution of strategy and the environment. Further, they felt diversified institutions benefit from opportunities for internal resource allocation and, therefore, can hold less capital and do more lending than more focused institutions. From the environment angle, they felt that drivers are innovation, regulations and technology

The book value is conditioned primarily by the endogenous factors such as profit generated, management attitude to share the wealth of the company with the shareholders and is more likely to stay stable. Further it is based on historical cost. Therefore, the increase in book value could be a best indicator of performance (Khan M.Y 2003). Although adoption of the risk-based standards has focused attention on capital levels, little if any attention has been given to the corresponding level of risk in bank portfolios and how the adoption of the risk-based capital standards may have impacted bank risk levels (Kevin Jacques & Peter Nigro 1997). Andres Almazan (2001) says “the regulatory shocks as a rebalancing of the optimal capital–expertise balance for banks in order to provide answers to this question about the effects of deregulation”.

Fries, Neven, and Seabright (2002) examine the effects of financial sector reform on the performance and competition of the banking sectors. In countries that have made significant progress on financial reforms, these authors find that banks make reasonable margins on loans, offer competitive rates on deposits, and make negative returns on equity, on average. In counties that have not proceeded very far in reforming their financial sectors, banks achieve high rates of return on equity but mainly at the expense of depositors, who are held hostage to low, sometimes negative, real returns on their accounts for lack of alternatives. Large block holdings are not homogenous and we therefore distinguish between types of stake holdings. Major sources of funds to these companies are bank borrowings and public deposits (Taxmann 2004). With the stock market scam, the exposure of Non-Banking Finance Companies in the form of lending on equities, initial public offerings are severely restricted to protect the interests of the depositors (Ingres 2006).

Many organizations in