by Gerhard Beukes, VP & Group Head of Fund Development & Management
Non-bank financial institutions (NBFIs) have been around for a long time, in various forms. Any institution with the ability to provide capital through loans or similar instruments to individuals or corporates can be classified as a NBFI. These entities do not accept customer deposits and are subject to less regulatory scrutiny than traditional banks, albeit oversights do exist. NBFIs represent various entities such as insurance companies, pension funds, investment funds, microfinance organizations and other specialty lenders. The instruments they provide to their borrowers are more expensive than loans or financings provided by conventional banks, due to a number of reasons, such as:
- a higher cost of capital,
- the likely increased risk profile of the borrower,
- faster timeline to funding,
- potentially weaker collateral on offer, or
- a relatively more complex borrowing scenario.
One of the most striking differences between conventional banks and NBFIs would generally be their cost of capital. While banks accept customer deposits at very low returns to these customers and have the ability to lend them out at reasonable margins, NBFIs are generally funded by investors seeking a strong return, which in turn leads to more expensive loans provided to borrowers. In lending out a reasonable amount of their available deposits and investable funds, however, both banks and NBFIs drive growth in the real economy.
In the Caribbean, non-bank financial institutions have been around for over a century, mostly in the form of insurance companies and credit unions. Most business owners in the region are familiar with the historical difficulties involved in obtaining bank financing, and these have largely intensified over time. Tremendous demand exists as a result of this lending-void—hence the pronounced interest rates attached to alternative lending. These rates are, however, what drive strong returns for the capital investors that back NBFIs.
Perhaps surprisingly, NBFIs now comprise about 50% of the financial sector globally, having expanded substantially since the great financial crisis. This dramatic growth is due to increased regulatory restrictions on conventional bank lending, which has opened the door for other entities to provide financing in an era of increased consumer demand for borrowing. Advances in technology, high liquidity levels, and heightened investor demand for high-return instruments have also fuelled growth and demand for alternative lenders. Yet, even as these global factors—which appear more pronounced in the Caribbean region—continue to support NBFI expansion, conventional banks remain the backbone of region’s financial services sector.
NBFIs serve as an important complement to the traditional banking ecosystem. From a business perspective, as long as a venture’s return exceeds the cost of an NBFIs price of borrowing (often in the strong double-digits range), demand for alternative lending will remain strong in the region. We anticipate continued market expansion, with the growth of new entrants and established entities hinging on access to stable, long-term capital. From the borrower’s perspective, expansion will enhance competition between NBFIs, reducing interest rates and increasing innovation—both of which bode well for the economy as a whole.
At some stage within the medium term, there will be a saturation point as demand is satisfied and sufficient market participants are providing solutions to potential borrowers. At this stage, appetite to invest in NBFIs will flatten out as the industry reaches a more mature phase. Regulatory constraints will also start affecting the operating models of NBFIs, requiring enhanced compliance while raising the operating cost base. This will squeeze operating profits, making the business less attractive for further investment.
While they may not ultimately reshape markets, NBFIs play a vital role in stimulating economy activity. They do so by enhancing the capacity of businesses and individuals to participate in the economy through the provision of accessible financing in a timeous manner. Regulators have begun to eye the NBFI sector with great interest, and while businesses generally squeal at the thought of regulatory tightening, such scrutiny is broadly a good thing: it protects consumers against potential aggressive practices and – in certain instances – against themselves.
