Five-Star Business Finance Ltd Management Discussions

1. Macro-Economic Overview

RBI Governor, in his foreword to the Financial Stability Report December 2023, states -

"As we come to the close of 2023, the global economy and the financial system continue to recover from successive high- intensity shocks over the last four years. There are multiple challenges on the horizon: slow and divergent growth prospects; elevated debt levels; growing geo-economic fragmentation; and prolonging conflicts. High interest rates and large fiscal deficits have added to debt servicing pressures in most countries. As growth prospects remain subdued, policymakers face a daunting task in balancing the pressing requirements of investment in critical public infrastructure, especially those relating to health and education as well as supporting the most vulnerable sections of society.

Inflation has been moderating and a sense of optimism about soft landing of the global economy is taking hold. Global interest rates have peaked in the current monetary policy tightening cycle, though macroeconomic conditions remain too fragile and uncertain for a definite view on growth and inflation conditions going forward. On balance, therefore, it would be prudent to proceed with caution on the evolving outlook and risks."

This statement sums up what the macro-economy (both domestic and global) generally and more particularly, the financial system has gone through for over the last 4 years or so. There have been quite a number of significant disruptions, which have ensured that the global economy always remained in some kind of fluidity and volatility.

What is also encouraging to note is that amidst all this volatility in the global macroeconomic environment, the Indian economy has been exhibiting a quickening growth momentum, with resilience and financial stability. The Financial Stability Report also notes -

"Moderating inflation, improving external position, continuing fiscal consolidation and a strong and stable financial system with fortified balance sheets are hallmarks of this transformation in the post-pandemic period.

Bolstered by strong capital buffers and robust earnings, financial institutions are supporting durable credit growth. At the same time, higher profits and lower leverage are contributing to sound corporate financials. Proactive and prudent policy actions and availability of policy buffers are steering the economy on a rising growth trajectory with stability."

From a financial services perspective, the banking sector continues to be resilient across various aspects of capital buffer, asset quality, profitability and growth.

The domestic banking system remains resilient, bolstered by strong buffers, robust earnings and the ongoing strengthening of balance sheets. The capital to risk-weighted asset ratio (CRAR) at end-September 2023 remained high at 16.8 per cent vis- a-vis the regulatory minimum of 11.5 per cent (including capital conservation buffer) while the common equity tier 1 (CET1) ratio, which represents the highest quality of regulatory capital, stood at 13.7 per cent as against the regulatory requirement of 8 per cent (including capital conservation buffer).¹

As far as asset quality was concerned, both coincident and leading indicators of asset quality, i.e., the gross non-performing assets (GNPA) ratio and the special mention accounts - 2 (SMA- 2) ratio, respectively, have fallen to multiyear lows of 3.2 per cent and 0.9 per cent, even as improved provisioning drove the net non-performing assets (NNPA) ratio to a multi-decadal low of 0.8 percent.¹

Healthy interest margins, strong credit demand and lower impairments have boosted net interest income (NII) of the banking system through the course of the current monetary policy tightening cycle, and strengthened earnings as reflected in RoA and RoE, which rose to 1.2 per cent and 12.9 per cent, respectively, in September 2023 from historical lows of (-) 0.2 per cent and (-) 2.2 per cent, respectively, in March 2018.¹

From a growth perspective as well, bank credit has seen a good momentum recently, and there have also been compositional shifts in the bank credit trends. Services and Retail Sector have seen increasing proportion of credit, and even in the retail sector loans, there has been a significant spurt in unsecured lending. The asset quality of banks has also seen improvement despite the sharp increase in retail lending.

One of the other developments that took place in the banking system, which facilitated the rapid growth in retail lending, was bank lending to NBFCs. Bank lending to NBFCs has been growing at a faster rate than the overall bank credit growth; increasing co-lending arrangements between banks and NBFCs has also been a point closely watched by the regulator; whilst there are no imminent signs of stress in the retail credit segment, given the procyclicality of lending and potential higher debt servicing costs, RBI undertook proactive regulatory measures such as increase in risk weights on certain segments of consumer credit by banks and NBFCs as well as bank credit to NBFCs, along with a strengthening of credit standards in respect of various sub-segments under consumer credit, to prevent build-up of risks and spillover to the wider financial system.

As regards NBFCs, they have been the conduits who have been taking credit to the large unserved and underserved segments, where banks did not have the ability to take a direct exposure.

As the Financial Stability Report notes, the NBFC sector has increased its footprint in financial intermediation, and this has been associated with a rise in connectedness with the traditional banking system. Given this level of interconnectedness between banks and NBFCs and possible contagion effect, senior officials of RBI have been making categorical statements advising NBFCs to look at non-bank avenues for their debt requirements. The Financial Stability Report also notes that there is an overall resilience in the banking system to manage any contagion risk that may emanate from such interconnectedness. However, RBI has also been quite vigilant and trying to be proactive to ensure there is no build-up of systemic risk in the banking system.

From all that has been stated above, it can be clearly noted that these are uncertain times and unless there is a good risk management and compliance framework, financial services ecosystem may have to face quite a number of challenges in the forthcoming quarters.

1.1. Outlook for Growth

From a global perspective, there has been a cautious optimism as regards the growth projection for FY2024 and FY2025. The World Economic Outlook updates of the International Monetary Fund have been getting more and more positive on the growth projections for FY2024 and FY2025. The updates in April 2023 and July 2023 projected a growth of 3.0% for FY2024, while a more recent update of January 2024 projects a growth of 3.1% in FY2024 and 3.2% in FY2025. The updates also note that the forecast for 2024-25 is, however, below the historical (2000-19) average of 3.8 percent, with elevated central bank policy rates to fight inflation, a withdrawal of fiscal support amid high debt weighing on economic activity, and low underlying productivity growth.

However, India seems to be in a much better position as can be deciphered from the April 2024 Monetary Policy Report and the statement of the RBI Governor. Excerpts from the Governors statement clearly evidence this fact - "Domestic economic activity continues to expand at an accelerated pace, supported by fixed investments and improving global environment. The second advance estimates (SAE) placed real GDP growth at 7.6 per cent for 2023-24, the third successive year of 7 per cent or higher growth... Going forward, the outlook for agriculture and rural activity appears bright, with good rabi wheat crop and improved prospects of kharif crops, due to expected normal south-west monsoon. Strengthening of rural demand, improving employment conditions and informal sector activity, moderating inflationary pressures and sustained momentum in manufacturing and services sector should boost private consumption. As per our survey, consumer confidence one year ahead reached a new high. The prospects of investment activity remain bright owing to upturn in the private capex cycle becoming steadily broad-based; persisting and robust government capital expenditure; healthy balance sheets of banks and corporates; rising capacity utilisation and strengthening business optimism as reflected in our surveys. Improving global growth and trade prospects, coupled with our rising integration in global supply chains, are expected to propel external demand for goods and services. The headwinds from protracted geopolitical tensions and increasing disruptions in trade routes, however, pose risks to the outlook. Taking all these factors into consideration, real GDP growth for 2024-25 is projected at 7.0 per cent with Q1 at 7.1 per cent; Q2 at 6.9 per cent; Q3 at 7.0 per cent; and Q4 also at 7.0 per cent. The risks are evenly balanced."

So, both the global and domestic economies are at a fairly uncertain, yet interesting phase and there are risks that are evenly balanced - how the events unfold, central bank reactions to possible headwind and tailwind events, would determine the growth of economies, which eventually will have an impact on the various sectors at large.

2. Industry Overview & Operating Environment

As of end June 2023, bank credit to NBFCs stood at 9.9% of total bank credit. Bank lending to NBFCs increased at a CAGR of 26.3 per cent during the past two years (i.e., from June 2021 to June 2023), well above the growth of 14.8 per cent in overall bank credit. Even during the second half of the current financial year, Bank credit growth remained robust with improving economic activity. Growth in non-food bank credit increased to 16.3 per cent (y-o-y) as at end-March 2024 from 15.4 per cent as at end-March 2023. The Monetary Policy Report also outlines that Services sector credit witnessed a healthy growth of 21.2 per cent (y-o-y) in February 2024 as compared with 20.5 per cent a year ago. Credit to NBFCs continued to be the largest contributor to this growth, though the pace moderated during the year. Overall, the key indicators of capital and asset quality of the banking sector as well as the NBFC sector continued to remain healthy.

As far as NBFCs were concerned, their metrics continued to remain robust. The Financial Stability Report notes that "Substantial capital buffers, improving asset quality and robust earnings have increased the resilience of the NBFC sector: the CRAR at 27.6 per cent in September 2023 remains well above the regulatory minimum of 15 per cent; the GNPA ratio has declined from a high of 7.2 per cent in December 2021 to 4.6 per cent in September 2023; and NIM and RoA stood at 5.1 per cent and 2.9 per cent, respectively, in September 2023. Healthy balance sheets have enabled NBFCs to consistently expand credit, which grew from 8.9 per cent (y-o-y) in September 2021 to 20.8 per cent in September 2023 (y-o-y)."

The above numbers stand testimony to the strength of the NBFCs. A press release by ICRA dated April 1, 2024 also notes that the asset quality of banks and NBFCs has been at its decadal best with the profitability and the capitalisation indicators expected to remain healthy in the near term.

Regarding the growth potential for the NBFCs in the coming years, the projections given by rating agencies range between 14% and 16% for FY2024 and between 13% and 17% for FY2025. As far as retail AUM of NBFC is concerned, the projection given by ICRA for FY2024 is 21-23% which is expected to moderate to 17- 19% for FY2025.

So, across the aspects of growth, profitability and quality, the metrics have been and are expected to be robust for the NBFCs. From a regulatory perspective, the Reserve Bank of India has been taking a very proactive stance in bank and NBFC regulation. Consequent to this, there has been a number of new norms that became effective for implementation during the financial year under review. These new norms span across domains such as KYC, Information technology, fair practices, etc.

3. Five Star - An Overview

Five Star is registered with RBI as a non-deposit taking systemically important NBFC. The Company is in the business of providing Secured loans to Small Business customers and Self-employed individuals who are largely ignored by the formal financial ecosystem. With experience of operating in this borrower segment for the last over two decades, the company has developed a unique underwriting model, which is capable of evaluating the creditworthiness of such borrowers, even in the absence of documentary evidences. The Company provides only secured loans which ensures robust asset quality, even during difficult times. The company operates in 520 branches across 9 states and 1 union territory and has a borrower base of close to 4 lakhs as on March 31, 2024.

Borrower Profile

The borrower profile of the Company predominantly consists of borrowers who are graduating to the formal financial ecosystem for the first time. While 75% of the Companys borrowers may have taken a product loan i.e. Microfinance loan, gold loan, vehicle loan, Five Star tends to be the first lender to these borrowers for a secured loan of INR 3-5 lakhs. As they graduate from the informal lending ecosystem, they can perceive 3 obvious advantages:

1. Lower interest rates - they can get funding at almost half of the interest rate that they would be paying to moneylenders.

2. Ability to amortise principal monthly - As they can repay principal monthly through the EMI structure, they are able to completely pay off the loan within their stipulated tenor. In the moneylending ecosystem, the ability to amortise principal monthly is fairly non-existent.

3. Fair & transparent practices - As they deal with a regulated lender, the practices are fair and transparent, which brings about tremendous confidence in the minds of the borrowers.

A major portion of the Companys borrowers are shopkeepers, typically providing essential services to the common man. There are also self-employed non-professionals to whom the Company provides loans, and these are also people whose services are indispensable. A small portion of the borrowers tends to be cash salaried individuals, who are unable to avail financial assistance from banks or the larger NBFCs. Our belief, which has been vindicated over the years, is that these people are largely insulated from any kind of economic disturbances, and even during periods of economic crises, they are the last to get hit and first to bounce back. So, their ability to repay the Companys loan remains largely unhampered. Also, given that their services are essential for every common man, their incomes also remain largely stable and predictable. All these factors contribute majorly to the strong asset quality that the Company exhibits.

Unique Underwriting Approach

As many borrowers graduate from the unorganised system and do not have documentary proofs of their incomes, traditional underwriting methodologies would be ineffective, and it becomes essential to tailor an underwriting approach that would help the company understand their cashflows. Towards this, Five Star has built a unique underwriting methodology underpinned on 3 Cs - Character, Cashflow and Collateral, which has helped the company build a strong and profitable loan portfolio over the last many years.

As much as it is important to evaluate the ability of the borrower to repay, it is equally, if not more important to establish the intent of the borrower to repay. Absence of intent would mean future complications, legal or otherwise, to effect repayment on the loan. Hence Five Star accords maximum importance to the intent of the borrower, which is evaluated through Neighbourhood checks, Trade checks, Credit Bureau report analysis, etc, through which we try to understand the character of the borrower. Good amount of time is spent by multiple teams to understand and establish the intent of the borrower.

Understanding and evaluating the cashflows in the absence of documentary evidence poses a unique challenge. However, Five Stars experience of operating in this segment over the last couple of decades gives it a significant edge in terms of understanding the borrower cashflows. Evidence is looked at to justify the cashflows - the evidence could be the lifestyle and living conditions of the borrower or the assets that the borrower has created for himself / herself and his / her family. Through thorough checks of the borrowers workplace, his / her residence, lifestyle, etc, the company is able to arrive at a plausible cashflow which will stand support to the loan repayment.

In addition to understanding the cashflow of the customer, the company also secures its loan by taking a hard collateral as security for the loan. The self-occupied residential property of the borrower serves as the collateral in about 95% of the loans, with the balance having non-SORP as collateral. But none of the loans are unsecured, which will ensure that the borrower prioritises the repayment on his / her Five Star loan over the other loans. This was visible during multiple crises times when the borrower could have defaulted on his obligations to other institutions but ensured that he / she pays up on a Five Star loan.

With this underwriting methodology, the Company ensures through its sound business model that the loans are underwritten on the basis of the cash flows of the borrowers which is the primary security and also backed up by the hard collateral as the additional security. This has effectively ensured a low percentage of NPA on the portfolio of business as reflected in the financial statements.

Business Growth

The Company is clearly growth focused as can be seen from the high growth rate that was seen during the years prior to COVID.

But this is not just growth for the sake of growth or reckless growth. Growth bereft of quality is something that is anathema to the company. Nothing better demonstrated this but for the couple of years of COVID - during this period, the Company just grew at about 14% each year. We were very clear that high growth during periods of crises is bound to lead to asset quality issues and hence we pulled back our growth.

FY2023 and FY2024 has again seen robust growth - we clocked a growth of ~37% in FY2023 and ~39% in FY2024, where the growth was led by an expansion in the number of branches and increased borrower base, rather than being led by an increase in average ticket size. This is a prudent way of growth rather than overburdening the existing borrowers through additional loans or through increasing the ticket size of fresh disbursements.

However, there has been a shift in strategy in the recent past, primarily from the perspective of risk diversification. We have moved to what we call as "Cluster branch" Strategy under which it is our belief that once a branch reaches a certain portfolio size, it would be prudent to open a new branch in the vicinity and also transfer some accounts from the existing branch to the new branch. This helps us achieve 2 objectives - firstly, the officers in the existing branch would get space to onboard additional accounts; and secondly, the new branch starts with a set of accounts rather than starting on a completely clean slate. This also ensures that the portfolio in a branch does not cross a certain threshold, which is also advantageous especially when there is a slightly higher level of attrition, etc.

So, the increased branch network is the result of new branches opened in the normal course of business along with new branches that have been opened consequent to the Cluster branch strategy. We believe that we can open about 80-100 branches every year, which will again be a mix of new branches and cluster branches. The state-wise split of branches as of March 2024 is given below.

The combined effect of increased loans and increased branch infrastructure resulted in a strong portfolio growth at around 39% for the year under review.

The Company uses 3 levers to facilitate its growth:

1. Increased branch infrastructure - as stated above, we believe that we can add 80-100 branches every year, which would mean at least about 500-600 officers who would be able to onboard incremental business. This is our primary level for growth.

2. Increase in average number of officers - With increased branch vintage, we could look at adding officers to the existing branches. Such additional officers would bring incremental business, which would also aid in our portfolio growth.

3. Increase in ATS (average ticket size) - The Company had operated at an average ticket size of about INR 3.50 lakhs prior to COVID. During COVID, with the borrowers going through some stress in cashflows, the company had consciously reduced its average ticket size on fresh disbursals. However, during the last couple of years, the borrower cashflows have started showing signs of good improvement showing them rebounding from that stress. Based on this, the Company also increased its ticket size on fresh disbursals and for the year under review, we have gone back to pre-COVID levels. We will continue to increase ATS at least for inflationary increases going forward, which would also contribute to the portfolio growth. However, even under such scenario, ATS of Five Star would still be much lesser than other industry players which helps Five Star from a risk perspective as well.

Collections & Asset Quality

Five Star is fundamentally a "Collections-first" company. One of the fundamental tenets of the company is to prioritise collections over incremental business. The ability to maintain strong collections efficiency and robust asset quality even during difficult times is a distinguishing facet of the company. Towards this, the company has always held the sourcing officer responsible for the collections also on the loans sourced by him / her. The incentives for the Field Officers and other branch staff have been structured in such a manner to ensure that they perform in an exemplary manner both on business and collections.

However, the company also understands that the same officer being involved in both business and collections forever impairs his / her ability to onboard new business. At the same time, completely delineating business and collections brings its own set of challenges like complete loss of accountability etc. Especially post the second wave of COVID, it became very important to have people with exclusive collections focus so that the deterioration in the softer buckets could be cured. Towards this, the company had created a collections vertical at each of the branches with necessary supervisory support and moving accounts with certain vintage to this team to ensure that the accounts are rolled back to better buckets.

The Collections vertical has worked extremely well for us, as can be evidenced in our current and 1+ portfolio which is at all-time high as of March 2024. The graph below depicts our Current and 1+ portfolio for the last 5 years, and the data is self-explanatory.

While there has been some denominator effect to these numbers, it is also to be noted that there has been decrease in absolute quantum in each of the delinquency buckets over the years.

Now that the situation is back to normal, the Company has also been evaluating its strategy of having a dedicated collections vertical in each of the states. Whether the objectives of the Company shall be better served with "Collections support" at each of the branches, which would work under the same branch manager and supervisory layer, or whether we would need "Collections vertical" is something that would be decided based on the needs and objectives of the Company. The Company may even evaluate having different strategies in different geographies depending on the needs of a particular geography.

The Company had also restructured a small portion of its portfolio as part of the COVID second wave; however, the proportion of the restructured book stands at a very marginal level (0.52% of the overall AUM as of March 31, 2024) as on date. Also, the restructured portfolio is performing well (76% of the restructured book is standard as on date i.e. 30 months post moratorium period), and we do not expect any major losses emanating out of this portfolio. In fact, we also carry a very sizeable provision on this book (we carry a provision of about 55% on this book), which we believe, would be more than sufficient to offset any potential losses on this portfolio.

During FY2023, the revised IRAC norms also became applicable for the Company, wherein daily movement of loans into NPA was mandated and upgradation norms were changed such that a borrower who was classified as NPA can be reclassified into Standard only after payment of all the arrear dues. The Company has aligned its Stage 3 assets to NPAs under the revised IRAC norms and the asset quality remained robust even after the implementation of the said circular. The table below gives the stage-wise details of loan portfolio, and the improvements are plainly visible.

Stage	As of March 31, 2024		As of March 31, 2023
	Amount in INR lakhs	% of AUM	Amount in INR lakhs	% of AUM
Stage 1	888,021.08	92.11%	618,839.65	89.49%
Stage 2	62,753.99	6.51%	63,249.70	9.15%
Stage 3	13,283.99	1.38%	9,393.86	1.36%
Total	964,059.06	100%	691,483.21	ALIGN=RIGHT>100%

As the borrowers are largely first-time borrowers to the formal financial ecosystem for a size and nature of the loan that they have taken from the Company, it is important to provide them with multiple options to make repayments on their loans. Given the Companys focus on Tier 3 to Tier 6 towns, where the digital penetration is not as high as the metros or Tier 1 and Tier 2 cities, it becomes necessary that they are permitted to repay in whatever manner they prefer. Towards this, the Company

had facilitated payments in both cash and other digital means. However, the Company has been consciously nudging the borrowers to make the payments through digital means, which is safe for both the borrowers and for the Company. The efforts of the Company have borne fruit and we have seen a significant uptick in the digital payments over the last few years, as can be seen from the data below.

4. Operational & Financial Metrics

4.1. Branches: The number of branches as at the end of March 2024 was at 520 as against 373 as at March 2023.

4.2. Portfolio growth: Five Stars Consolidated AUM increased from INR 6,914.83 Cr in FY2023 to INR 9,640.59 Cr in FY2024, which translates to a growth of about 39% for the year.

4.3. Loan disbursals: During the year, the company disbursed an amount of about INR 4,881 Crores as against INR 3,391 Crores in the previous year, recording a growth of 44% for the year under review.

4.4. Asset quality: For the financial year ended 31st March 2024, the company achieved a Gross Stage 3 assets / NPA of 1.38%, as against 1.36% in the previous year.

4.5. Capitalisation: As of March 31, 2024, the Company had a net worth of INR 5,196.15 Crores. The Company had been listed in the stock exchanges since November 2022 and had not seen any fresh issue of shares post listing, except for exercise of stock options by eligible employees. But for this, the entire accretion to the net worth is on account of the Profit after Tax for the current financial year.

4.6. Profitability: The Company continues to remain very profitable and the full year Profit After Tax for the period ended March 31, 2024 was INR 835.92 Crores as against INR 603.50 Crores for the financial year ended March 31, 2023.

Some of the operational and financial highlights are given

Parameter	FY 2024	FY 2023	Growth
Assets under Management (INR Cr)	9,640.59	6,914.83	39.42%
Amount disbursed (INR Cr)	4,881.43	3,391.44	43.93%
Branches (#)	520	373	39.41%
Number of customers	385,966	293,954	31.30%
Number of employees	9,327	7,347	26.95%
Profit after Tax (INR Cr)	835.92	603.50	38.51%

below.

5. Strengthening Liability Profile

Given the strong capital profile of the company and the significant net worth on the balance sheet, the company was not required to raise a high quantum of incremental debt during the past few years. Only in the last couple of years has the Company become quite active in the debt space and we have managed to borrow good quantum of debt during each of these financial years. Despite this, the Companys ability to borrow was unhampered as we had had demonstrated our ability to borrow good quantum of incremental debt even during years of stress viz. year of demonetisation, year in which large NBFCs

went down leading to heavy unavailability of debt for the NBFC sector, years of COVID 1 and 2.

During the financial Year under review, your Company has availed fresh borrowings aggregating to INR 3,929.12 Crores as against INR 3,103.56 Crores in FY2023. While the Company had secured sanctions of INR 4,354.12 Crores, the balance portion remained unavailed and available for availment in the coming FY. The outstanding Total Borrowings as of March 31, 2024 were INR 6,315.84 Crores. Not just in quantum of borrowings, the Company also managed to get their borrowings at very competitive rates (all-inclusive pricing) as is shown below.

As can be seen from the graph above, during the last 2 financial years (FY2023 and FY2024), the Company managed to obtain borrowings at very competitive rates despite a very adverse interest rate environment when the repo rate went up by 250 bps since March 2022. During this period, the cost of incremental borrowings for the Company went up only by about 83 bps. During the current year, the company also onboarded new

Structure-wise debt outstanding is given in the graph below:

lenders such as NABARD, Canara Bank, Deutsche Bank, Qatar National Bank and Royal Sundaram General Insurance.

The Company has borrowed moneys through term loans from banks and financial institutions, cash credit lines from banks, issued non-convertible debentures, issued pass-through certificates as part of Securitisation transactions and also availed one tranche of non-rupee denominated borrowing through the ECB route. So, the debt profile of the company is well diversified both from the perspectives of type of lenders as well as the structure of debt.

The Company had consciously tapped into banks for its borrowings during the last couple of years, primarily because banks were lending a sizeable quantum of debt at the appropriate cost. There were also banks across public sector banks, private banks and foreign banks that had hitherto not lent to the Company and who evinced an interest to provide funds to the company. So, it was advantageous for the company to onboard these lenders which also helped diversify within the bank lending universe.

The Company had also taken a conscious call to achieve diversification outside the bank lending universe as well, in the years to come. The facility from NABARD, one of the largest developmental financial institutions in the country, is a step in this direction. The Companys borrower profile being unserved or underserved borrowers, would help NABARD achieve its developmental objectives as well.

The Company would continue to onboard the right kind of lenders who can support the Company in achieving its long- term objectives, albeit at an appropriate cost and also with an eye on the right mix, both from the perspectives of lender category and borrowing structure.

Leverage: Given the healthy capital profile, the company has been operating at a low leverage and low D/E ratio. During the year, the D/E ratio is reached 1.22x and it would be the endeavor of the company to touch optimal D/E ratio levels in the years to come.

6. Asset-Liability Management:

One of the important requirements for a NBFC is to manage its liquidity in the most efficient manner. Too less liquidity in a stressful situation could lead to a survival crisis for a NBFC; on the other hand, too much liquidity would lead to negative carry and create a dent on the financials. Hence the right liquidity balance is extremely important for the success of a NBFC. And the liquidity position is directly linked to the Asset-Liability Management (ALM) practice of a NBFC.

ALM is generally given much less importance than what it deserves. Whenever there is a price arbitrage between long- term and short-term borrowing, it is important to look at this from an ALM perspective rather than just preferring short-term gains. Large banking corporations over the past many years have crumbled, primarily due to their failure to have a healthy ALM position. However, Five Star has always been following a conservative ALM and liquidity policy, which has helped the company manage all turbulence that it has faced over many years. The Company does not resort to short-term borrowing of significant quantum given that it lends for up to 7 years. The liquidity policy defines a minimum liquid balance to be maintained on a monthly basis which will effectively take care of all obligations and other fund requirements over the next 3 months. The Company is of the view that while this may entail some amount of negative carry, it provides a good balance to manage adverse times, should they arise.

The Liquidity coverage ratio, which is a measure of the next 30 days liquidity position, is also maintained at a very conservative level. This is an offshoot of our liquidity policy, which mandates certain minimum level of liquidity to be carried by the Company. The LCR as of March 31, 2024 was 316%. To maintain High-Quality Liquid assets (HQLA) to manage its LCR, the company has been investing in Government Securities and Treasury Bills, which qualify as HQLA for the purpose of LCR computations.

Again, given the liquidity that we carry at any point of time, the Company always maintains positive cumulative ALM across all buckets, which helps weather any kind of shocks that may come about. As has been seen in the past, even during extremely stressful periods from a liquidity perspective, the Company has been able to manage all its outflows without resorting to any kind of concessions from its lenders.

7. Corporate Governance:

The RBI Governor, in his Monetary Policy Statement, stated the following - "Let me emphasise here that banks, NBFCs and other financial entities must continue to give the highest priority to quality of governance and adherence to regulatory guidelines. Financial sector players, by and large, operate with public money - be it of depositors in banks and select NBFCs or investors in bonds and other financial instruments. They should always be mindful of this. The Reserve Bank will continue to constructively engage with financial entities in this regard. It needs to be recognised that financial stability is a joint responsibility of all stakeholders."

The Company has always given a very high level of importance to Corporate Governance. The Board of Directors comprises of eminent individuals with strong expertise in the financial services sector. The Company has also inducted functional experts in the Board of Directors to ensure that specialised skills are also brought in wherever required. The Board is very well diversified, with balanced representation from the Promoter group, Investor Nominees, Independent and Non- executive directors.

The Board of Directors, in consonance with the Senior Management, provides the strategic direction to be taken by the Company. The Directors are also responsible for ensuring compliance with all the regulations and guidelines prescribed by various regulatory authorities. The Board is also assisted by multiple sub-committees, where directors with specialised expertise act as members of such sub-committees and get into the depth of the subject on hand. The details of sub-committees and their roles and responsibilities can be found in detail in the Corporate Governance report.

8. Human Resources:

Amongst the four factors of production, viz. land, labour, capital and entrepreneurship, human capital is the only one that is capable of managing and directing the other 3. Amongst all the capital in this world, human capital is always the strongest and most enduring. Without human capital, the other 3 factors of production cannot be put to productive use. It is extremely essential to have the right people at the right positions so that they would be able to help the organisation achieve its objectives.

At Five Star, employees are the fulcrum around which every other factor revolves. No decision is taken without keeping the interests of employees in mind. The welfare of employees is at the heart of all decisions right across hiring, training, retention, performance appraisal and rewards and recognitions. The Company had employed 9,327 employees as of March 31, 2024 as against 7,347 employees as of March 31, 2023.

The business model of Five-Star is quite human intensive. Given the kind of borrower profile we cater to, it is not possible to completely eliminate the human element. While the Company leverages the power of technology to achieve higher level of efficiency and effectiveness, the business model has been built in such a way that human touch can never be replaced by technology. Technology can help complement the human element, but it cannot substitute the same. Hence it becomes important to hire the right talent and put them in the right positions so that they are able to use their expertise for the mutual benefit of themselves and the Company.

Moreover, it is also a heartening fact that the Company can provide employment to many people, more so in the local areas where they live. The fact that employees get to stay with their family, earning a good salary to take good care of their families makes them feel a kinship with the organisation. The Company has tailored the right incentive schemes to reward the high- performers and keep their morale high. In addition, more than 300 people at the field level (non-HO staff) have been given stock options wherein they will get to become owners of the company at a later point of time.

The field execution team is led by a strong Management team consisting of professionals with years of experience and expertise in the fields of banking and financial services and who bring their rich expertise to lead their respective functions. There are 21 professionals heading their respective functions across the various verticals. It is also heartening to note that a number of these professionals have been associated with the company for many years. The company shall keep making the necessary hires at the right time to ensure that the right people are at the helm of each function and are able to provide necessary oversight.

With the right strategy developed in consonance with the Board of Directors, the Management team develops the key action plans that are needed to achieve fruition of the strategy. The action plans developed by the Management team are put into action by one of the best execution teams, that consist of people with a "never-say-no" attitude. This three-pronged approach has helped the Company become one of the strongest and safest growing NBFCs over the last many years.

9. Technology:

Our journey towards becoming a technology-enabled company started in FY2017. Till then, we were largely paper led. We moved into a cloud enabled ERP starting April 2017 and since then have made significant strides in our technology journey. During the current financial year, we have made numerous developments on the technology front moving to strong platforms across various domains and thereby by upgrading our stack.

Technology has become a significant business driver in the last few years. The Company has used technology to complement its underwriting, collections and other operational processes towards making the processes more effective and efficient, reducing turnaround time, aiding in better data analytics and developing robust risk management strategies. The Company has been making strategic investments in information technology systems and implemented automated, digitized technology-enabled platforms and proprietary tools, to strengthen its offerings and derive greater operational, cost and management efficiencies. As shown in the picture above, we have implemented multiple new applications during the current financial year, which, we believe, would help in our journey towards becoming one of the leading players in the Small Business Loans lending segment. Further, in the coming years, our focus on technology shall be made towards the following areas:

A Improving accuracy and breadth of customer data capture across our portfolio for purposes of analytics and insight generation;

B Use data, predictive analytics and machine learning to complement our current underwriting processes to ensure we onboard the most suitable borrowers and maintain a robust asset quality;

C Developing a robust customer credit scoring model;

D Automation of existing manual activities within our underwriting process to reduce turnaround times for loan sanctions and reduce transaction costs; and E Supplementing our collections infrastructure by leveraging existing payment architecture towards collecting EMI repayments from our borrowers;

F Implementation of a Collections system, that can help optimise the efforts of our Field Officers and Collections Support team and thereby ensure focus on accounts that need attention with a clear focus on improving our DPD buckets.

The Company has made significant investments in both building the right team and also in the necessary hardware and applications. In addition to employees on the rolls of the Company, we have also tied up with a vendor who provides off- shore development capabilities to supplement the efforts of the Companys staff, thereby ensuring on-time delivery of projects.

Safety and Privacy of customer data is taken very at Five Star and towards this, the company has put strong technology infrastructure, which is completely cloud-based with adequate levels of safety. Annual Information Security audit is also undertaken by an independent firm and the findings / observations are taken very seriously and remediation measures are given utmost importance. The IS auditor also makes their independent presentation to the IT Strategy Committee and all the items pending resolution are tracked through the ATR mechanism.

The Company also has an IT Steering Committee, consisting of members from the Management team, and an IT Strategy Committee consisting of Board Directors and members from the Management team, and this Committee reviews, at least on a half-yearly basis, all the technology deliverables, benchmarks the technology architecture of the Company against some of the best practices being followed by other industry players and also provides strategic inputs on the way forward from a technology perspective.

From a security perspective, there is an Information Security Committee, consisting of the members from the Management team, that looks at all aspects of data security, data privacy, vulnerabilities, if any, and also tracks items pending for resolution. The Minutes of such meetings are also tabled to the IT Strategy Committee and to the Board of Directors for their noting and approval.

The Company believes that the adoption of such digital service delivery mechanisms has and will continue to enable us to be more efficient, customer friendly and over time improve cost efficiencies through automation, and perform more reliable data analytics for customized products to suit the diverse requirements of our customers and improved customer satisfaction.

10. Risk Management and Audit Framework:

The Company has a robust Risk Management framework which lays down the overall approach, including policies, processes, controls and systems, through which risk appetite is established, communicated as well as monitored. From a risk management perspective, the Company follows the "3 lines of defence model" wherein:

a. The first line of defence will be the Business and Support Units that will own the risks and manage the same, as per laid down risk management guidelines. The primary responsibility for managing risks on a day-to-day basis will continue to lie with the respective business units of the Company.

b. The second line of defence will be the Risk Management Department that would support the first line of defence by drawing up suitable risk management guidelines from time to time to be able to manage and mitigate the risks of the Company.

c. The third line of defence will be the Audit Functions - primarily the Internal Audit functions that are supported by External Audits. The third line of defence focuses on providing the assurance that the risk management principles/policies and processes are well entrenched in the organisation and are achieving the objective of managing the risks of the organization.

Through the aforementioned model, the risks of the Company are managed effectively. Being in the lending business, the Company is exposed to the following risks:

The Company has constituted a Risk Management Committee, which consists of members of the Board with years of experience and expertise across one or more of these areas and which meets at periodical intervals to discuss the various risks. The primary focus is on the portfolio composition and characteristics, and various cuts of the portfolio are presented to the Committee. The Committee undertakes in-depth discussion on the existing and possible risks that may emanate and the proactive actions that could be taken to mitigate these risks. In addition to portfolio analysis, the Liquidity Risk Management Framework is also discussed in detail, to understand the composition of the Companys liabilities. In addition, there are also discussions around HR risks, operational risks along with reviewing the Key Risk Indicators. On an annual basis, the RMC also undertakes the ICAAP (Internal Capital Adequacy Assessment Process) assessment to understand possible implications on the capital position of the Company.

A very comprehensive risk management policy has been put in place detailing the mitigants available in the processes to manage each of these risks. Additionally, Key Risk Indicators (KRIs) have also been laid down for each of the risks associated with the elements mentioned above. The KRIs are tracked on a periodic basis by the Risk Management Committee. The RMC is kept informed of the limits for each of these KRIs, and whenever the actuals come close to breaching the limits specified, RMC clearly specifies corrective actions to be adopted by the Company.

From an underwriting perspective, the business model of the Company has been tailored to ensure that all the activities are done by people who are employed on the rolls of the Company. Be it sourcing, credit assessment or collections, all the activities are carried out by the Companys employees. As already stated, the Companys underwriting model hinges on 3 Cs - Character, Cashflow and Collateral, which is evaluated by 2 sets of people - business team, which has a vested interest in the proposal but still given the responsibility of verification in order to fix responsibility and accountability, and credit team, which does not have any incentive to sanction a file. This ensures that there is a strong maker-checker mechanism in place. Not only in the underwriting process, the maker-checker process is an inherent part of every single process undertaken by the Company and acts as one of the strongest risk management strategy.

During FY2023, the company had implemented the Risk-based Internal Audit Framework (RBIA) as mandated by the Reserve Bank of India. Under this framework, the Companys processes are evaluated for the inherent risks and classified into high risk, medium risk and low risk processes. The audit scope and coverage are then determined based on the risk characteristic of the underlying processes. The Companys audit process is overseen by the Audit Committee of the Board and is broken into 3 parts - Statutory Audit undertaken by the Statutory Auditors, Internal Audit undertaken by an external audit firm and Internal Process audit undertaken by an in-house audit team.

All the aspects across regulatory compliance, company specific policies and procedures, financial reporting and adherence to accounting standards, etc are covered and reported to the Audit Committee of the Board.

As stated above, the RBIA framework of the company has analysed all the functional processes, understood the risks inherent in such processes and tailored an audit scope which is in line with the risk profiles. The Companys audit function is headed by a Chief Audit Officer (CAO), who is a senior professional with years of experience in the audit function. The findings of the audit exercise are presented to the Audit Committee on a quarterly basis and also reported periodically to the Board.

11. Internal Financial Controls:

The internal financial control over financial reporting is a process that is designed to provide reasonable assurance regarding the reliability of financial reporting and preparation of financial statements for external purposes in accordance with the generally accepted accounting principles. The Companys Internal Financial Control system has been designed commensurate to the size and complexity of the companys business and operations. The control system is designed to provide a high degree of assurance regarding the effectiveness and efficiency of the controls and mitigants to ensure that the operations and processes remain at acceptable levels, as far as possible.

The following are the types of controls documented and tested as part of the Internal Financial Controls testing. The Controls are based on the type of the Risks addressed:

Operational Controls: Controls designed and implemented to address the operational level risks or non adherence to the policies and practices of the Company.

Financial Controls: Controls designed and implemented to address the risks of having a financial reporting impact or misstatement in financial statements of the Company.

Compliance Controls: Controls designed and implemented to address the risk of non-compliance with the relevant statutory guidelines / provisions of the law of the land.

The Company has engaged an external audit firm to review the risk control matrices on a periodic basis and undertake a comprehensive testing to certify the efficacy of internal controls and suggest improvements as may be required. Their findings are presented to the Audit Committee on a periodic basis. This ensures that there is an external validation to the efficient workings of the process and financial controls that have been put in place by the company.