Why niche banking matters

The Shriram group has succeeded by taking credit to its last mile, where commercial banks typically fear to tread.
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Providing credit for the little man can be big business (AFP)
<div style="text-align: left;"> Providing credit for the little man can be big business (AFP) </div>

The combination of retail and commercial lending with investment services, or universal banking, has long been the Holy Grail of the finance industry. In theory the model allows for unimaginable efficiencies that reduce the cost of capital for every kind of borrower and provides the rationale for an integrated financial services business.

But most banks, despite their best intentions, are anything but universal. They often fail to touch even those within their reach and most in need of their services. Yet their failure creates opportunities for anybody willing to make the effort and the Chennai-based Shriram Group is a case in point.

Group founder R Thyagarajan learnt a lot about small-business risk in his more than 25 years in the general insurance industry. A statistician by training, but an entrepreneur at heart, he set up a chit fund in Chennai for white collar employees in 1974. It was a small beginning but he soon found what he was looking for — a virtual goldmine in the used-truck finance business.

“This is a highly fragmented industry. Some 50% to 60% of truck operators in India are single-truck owners, but they are critical to the economy,” said Thyagarajan, a man of simple tastes all too evident in his spartan office in central Chennai. “The banks lacked the ability to evaluate credit risk in financing truck purchases, especially of second-hand ones, so that job was mostly left to money lenders.”

In 1979, Thyagarajan set up Shriram Transport Finance Company to address this market. Today STFC, with $6.6 billion in assets, is not just the flagship of the Shriram Group but India’s largest asset-financing non-banking finance company (NBFC).

As R Sridhar, the company’s Mumbai-based managing director explained, “Our philosophy is to fight the notion of the high-risk, un-bankable customer and it has taken us two decades to change that mind-set. In fact, it’s the ability to deliver the last mile of credit that’s the essence of the NBFC.”

STFC is a deposit-taking NBFC; but unlike a bank its borrowings are limited to fixed deposits, debentures and bank loans. In 1984 the company raised funds through an IPO and attracted small investments from truck makers Tata Motors and Ashok Leyland. Even so the company faced a serious liquidity crunch in 1998 following the collapse of a few shady NBFCs and tighter regulation by the central bank.

So STFC had to innovate to keep growing. “We approached GE Capital and Citi and proposed that we could expand their retail finance business if they allowed us to manage their truck finance portfolios,” said Sridhar. They agreed and so with just 10% equity participation, STFC leveraged Citi’s and GE Capital’s balance sheets to expand its truck financing network, earning management fees for the effort. But this was still restricted to the new truck business.

Next it had to persuade them to invest in financing old trucks, the riskier but more lucrative end of the trade. “We decided that securitisation was the way. We pooled Rs1 billion ($22 million) of used-trucks loans and successfully sold the portfolio to Citi,” said Sridhar. That model not only gave STFC a steady source of refinancing to expand its business, but provided Citi access to an entirely new retail finance segment. By 2003, Citi’s truck finance portfolio had crossed $1 billion.

But Citi had already been persuaded of STFC’s talent. In 2002, Citi took a $4 million stake in the company followed two years later by Axis Bank (erstwhile UTI Bank) and Reliance Capital. “This gave us tremendous credibility in the market,” said Sridhar. “Here were two large banks investing in an NBFC when most were struggling to stay afloat. Citi became our brand ambassador.” By 2005, STFC attracted its first private equity investment from ChrysCapital; TPG followed in 2006. By 2009 STFC was strong enough to acquire GE Capital’s entire truck financing business for $250 million.

Private equity investors have long understood the value of investing in the Shriram Group. According to Chennai-based research firm Venture Intelligence, group companies, whether holding companies (such as Shriram Capital), NBFCs (STFC and Shriram City Union Finance) or engineering firms (Shriram EPC and Orient Green Power) have raised about $700 million from PE investors including TPG, ChrysCapital, ICICI Venture, Ascent Capital, Norwest, Bessemer, New Vernon and Merrill Lynch.

The group’s real estate arm, Shriram Properties, has also raised $475 million from investors including ICICI Venture, Starwood Capital, TPG, Hypo Real Estate and Sun Apollo Ventures. Many have made windfall gains cashing out of group companies. For instance, ChrysCapital sold its stake in STFC in 2009 for an estimated 13 times what it originally invested and TPG also reportedly plans an exit at roughly an 8-fold multiple.

Today the Shriram Group’s footprint stretches from commercial vehicle finance to life and general insurance and chit funds to investments in manufacturing to pharmaceuticals, information technology and property development.

Diversification for Thyagarajan was not simply a question of hedging his bets.

“It was not so much cross selling as using an existing relationship to develop a new business,” he said. Given Thyagarajan’s background in general insurance, truck r finance logically led there too. But when the company found that its chit fund agents were being poached by the slew of new entrants in the insurance industry, the head of the division suggested they too start selling life insurance, which was launched in collaboration with Sanlam of South Africa.

But more important for the Shriram Group, new ventures are essentially about the people who would `own’ them. As a former senior manager in the group said, “Thyagarajan won’t launch a new business just because someone comes up with a great idea. That person must be passionate about creating and growing it.”

The operative word in the Thyagarajan dictionary is relationship. “What we have created is a culture of trust, of persuasion, of friendliness, of fairness and understanding. That is why we are so successful in collecting money, in recovering our loans, in running our businesses,” he said.

As the former manager observed, “Thygarajan has incredible people management skills. He has built his business entirely on the entrepreneurial strengths of his colleagues. He won’t say your ideas are good or bad but, with a lifetime of assessing risk, will paint possible scenarios based on different assumptions. If you still think your approach is best, he will back you totally.”

The Shriram Group is owned by the Shriram Ownership Trust, a collective of the group’s 32 most senior executives.

Thyagarajan, who owns just 2% of its equity, is merely a first among equals. “Most banks, despite their best intentions, are anything but universal.”


This story was first published in the April 2011 issue of FinanceAsia magazine

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