Shriram City Union Finance Ltd Merged Management Discussions

COMPANY OVERVIEW INTRODUCTION

Established in 1986, Shriram City Union Finance Limited is one of the leading NBFCs in the retail finance industry, providing timely borrowings to its customers and delivering value to its stakeholders. The Company is present in 986 branches in India through its offices with AUM of Rs 33,186 crores as on March 31, 2022. The Company provides loans for businesses, for purchase of two-wheelers, commercial vehicles, against pledge of gold, against property and personal loan. The Companys subsidiary, Shriram Housing Finance Limited is a housing finance organisation registered with the National Housing Bank (NHB). The primary operation of the Company is providing loans for the purchase or construction of residential space and loans against property.

AUMs as on March 31

(Rs in crores)

2021-22	2020-21	2019-20
33,186	29,571	29,085

Product-wise Performance

(Rs in crores)

Loan Type	Disbursement in 2021-22	AUM in 2021-22
MSMEs	6,972	14,718
Gold Loans	6,532	4,078
Two Wheelers	6,295	7,764
Personal Loans	3,987	4,068
Pre-owned Two Wheelers	1,123	1,025
Loan against Property	693	789
Auto Loans	538	744
Total	26,140	33,186

KEY HIGHLIGHTS 2021-22

• Steady growth in disbursements and AUM

• Improved profitability, asset yield and net-interest margins of 16.63%, 20.81% and 12.74%, respectively

• Comfortable ALM position across timelines

• Supported by strong collections

• Steady and strong credit ratings

• Digitisation in the overall processes, leading to efficient operations and higher level of customer convenience

Key Financial Ratios as on March 31,

Key Ratios-IND AS	2022	2021
Return on Average Total Assets (Annualised)	2.92%	3.10%
Return on Average Net-worth (Annualised)	13.06%	13.50%

Key Ratios-IND AS	2022	2021
Earnings Per Share (?)(Basic)	164.16	153.16
Book Value Per Share (?)	1,309.96	1,197.70
Capital Adequacy Ratio (CAR)	26.78%	28.64%
Interest Coverage Ratio	1.58	1.65
Debt-Equity Ratio	3.51	3.23

OPPORTUNITIES AND THREAT Opportunities

• Industry leadership with dominant position

• Serving the under-served retail markets

• Strong brand pedigree and successful track record

• Wide product range and growth-accretive business fundamentals

• Robust financial management with balanced ALMs and lower NPAs

• Strong distribution network

• Business conducive environment with Governments focus on promoting MSME and Start-ups

Threats

• Regulatory challenges and credit availability

• Steep competition at the national level

• Product commoditisation

ECONOMIC REVIEW OVERVIEW

The financial year 2021-22 set off on a positive note with resumption of economic activities, along with Indias GDP growing at around 20.3% in the first quarter. However, the second wave of Covid-19, followed by partial lockdowns, hampered this progress although with less effect on the economy. Despite the second wave, India managed to achieve satisfactory growth backed by effective and speedy vaccination drives along with improved containment efforts. During the third quarter of the financial year, global inflation, rising crude oil prices and supply chain disruptions, led to a slower growth rate - further weakening the position of Indian rupee compared to US dollar. The Indian rupee ended as Asias worst-performing currency for Calendar Year (CY) 2021. The Government raised its spending to tackle the pandemic and related concerns, thereon widening the budget deficit. According to Fitch Ratings, Indian economy is expected to witness estimated GDP of around 8.7% in 202122. Financial year 2020-21 witnessed the COVID-19 induced lockdowns and disruption of critical services, leading to decline in GDP to -6.6%.

On a positive note, the Government announced the Production Linked Scheme (PLI) across 14 key sectors, involving a capital infusion of Rs 4 Trillion over the next five years. The PLI is expected to enhance the manufacturing capacities by 15-20%. Besides, the Gati Shakti: National Master Plan launched by the Government involving a spending of 100 crores will further promote infrastructural development. The resultant impact would provide impetus to the manufacturing sector, increase employment generation, and reduce dependence on imports while generating higher exports.

India - Forecast Summary

(%) FY starting April	Annual Avg. 2017-2021	FY20-21	FY21-22F	FY22-23F	FY23-24F
GDP	3.8	-6.6	8.7	8.5	7.0
Consumer spending	4.3	-6.0	9.1	12.1	5.8
Fixed investment	4.4	-10.4	11.9	4.9	7.2
Net trade (contribution pp)	-0.9	1.4	-3.0	-2.1	0.6
CPI inflation (end-year)	4.6	4.6	5.7	4.6	5.0
Policy interest rate (end-year)	5.28	4.00	4.00	4.75	5.00

F: Forecast

(Source: Fitch Ratings)

OUTLOOK

The Russia-Ukraine conflict, and the economic sanctions imposed thereon has rapidly translated into escalation of energy costs, supply-chain disruptions, and inflation. As a result, causing a spike in crude oil prices, adding to the inflationary pressure. As per Fitch Rating, India is likely to grow at a slightly slower pace of 8.5% in 2022-23, driven mostly by the Governments aggressive fiscal stimulus and capital spending.

INDUSTRY STRUCTURE AND DEVELOPMENTS INDIAN FINANCIAL SERVICES SECTOR

Indian Financial Services Sector comprises of commercial banks, insurance companies, non-banking financial companies, co-operatives, pension funds, mutual funds, and other smaller financial entities. The past few years have been exciting for this sector with multiple themes emerging and trying to gain market foothold.

The Government of India along with the Reserve Bank of India (RBI), introduced several reforms to liberalise, regulate and enhance this industry. Various measures have been undertaken in order to facilitate easy access to finance for Micro, Small and Medium Enterprises (MSMEs). These measures include the launch of Credit Guarantee Fund Scheme for MSMEs, issuing guideline to banks regarding collateral requirements and setting up a Micro Units Development and Refinance Agency (MUDRA). Some of the key trends observed during the period include:

Growing demand: Increasing household income is driving the demand for financial services across income brackets. Emergence of fintechs: Driven by rapid expansion of mobile and internet connectivity, India has over 2,100 operating fintechs on course to become one of the leading names as among the largest digital markets.

Data consolidation: In September 2021, eight Indian banks announced to roll out Account Aggregator system, enabling consumers to consolidate all their financial data at one place. Policy support: The Government approved 100% FDI for insurance intermediaries, and increased FDI limit in the insurance sector from 49% to 74%, under the Union Budget 2021-22. Besides, International Financial Services Centres Authority (Banking) Regulations 2020, shall drive and facilitate constituent operations in the IFSC, enabling the sector to reach its potential.

Growing penetration: With increasing disposable income and internet connectivity improvements, credit, insurance, and investment penetration is rising in rural areas alongside combined push by the Government and private sector, India stands to be among the worlds most vibrant capital markets.

INDIAN NON-BANKING FINANCIAL COMPANIES (NBFCS)

NBFCs form an integral part of the Indian financial system. It supplements the role of the banking sector, creating a passage to connect the less-banked customers to the financial services and thus paving way for inclusive growth. Furthermore, NBFCs streamline their business model through efficient use of technology, data analytics and artificial intelligence, leading to enhanced customer experience and strong credit assessment. The NBFCs are judged by asset- quality, profitability, exposure to sensitive sector and capital adequacy of NBFCs.

RBI is constantly striving to bring necessary regulatory changes in the NBFCs to ensure financial stability in the long- run. Despite sluggish economic growth, NBFCs witnessed growing market share despite pandemic-induced slowdown, lower demand, and sharper bank focus on retail loans, during 2021-22. There is increased regulatory oversight and push towards convergence with banks through scale-based regulation, re-alignment in asset quality classification, NPA recognitions, provisions, and prompt corrective action norms, among other measures.

OUTLOOK OF NBFCS

The outlook for NBFCs is expected to remain stable owing to a better operating environment and favourable regulatory measures. Sufficient capital buffers, stable margins, and sizeable on-balance sheet provisioning with adequate system liquidity, would further streamline competitive funding. Potential threat remains of any further pandemic waves or unfavourable interest rates and asset quality issues. As per India Ratings, the annual loan growth for NBFCs is likely to be around 14% in 2022-23. The sector is probable to observe normalcy in disbursements alongside increased demand for products, like loans against property, housing loans and vehicle finance, while personal and unsecured business loans too witnessed high demand during the pandemic. Growth in the vehicle finance segment is largely dependent on the increase in borrowers confidence and availability of vehicles - currently facing component shortage following the pandemic.

INDIAN MSME SEGMENT

The Indian MSME sector is considered to be the backbone of the Indian economy. It contributes significantly to the national socio-economic development, employment generation, and development of the backward and rural areas. The Government of India established the National Board for Micro, Small, and Medium Enterprises (NBMSME) under the Micro, Small, and Medium Enterprises Development Act, 2006. NBMSMEs examine the factors affecting the promotion and development of MSMEs. It is responsible for reviewing the existing policies and suggesting recommendations to the Government for further growth in the MSME sector. MSMEs contributes to Indias economic growth through a vast network of about 6.3 crores units, producing more than 8,000 products. It comprises 30% to Indias nominal GDP and 33% to the manufacturing output. Around 50% of the MSMEs operate in rural, generating 45% of the total employment.

The budget allocation for the year 2021-22 has doubled to Rs 15,700 crores, as compared to Rs 7,572 crores in the 2020-21.

OUTLOOK OF MSMES

The impact of the pandemic is eventually waning away, and the economy is steadily gaining back its momentum. India is now on the verge of a digital breakthrough and Industry 4.0, has made inroads across sectors, boosting the digitisation process by nearly a decade. MSMEs experienced a seamless digital transformation without considerable investments or modifications to the prevailing strategies. Overall, the general outlook for MSMEs is expected to improve, influenced by easing liquidity stress and steady asset quality.

ROLE OF NBFCS ACROSS DIFFERENT FORMS OF FINANCING MSME

Financing

NBFCs are preferred by MSMEs because of their ability to not only complement but also substitute banks for reaching remote areas, quick decision-making, and availing prompt services and expertise in niche segments. Moreover, the financial institutions have started to acknowledge the cash flow-based lending approach, instead of asset-based secured lending, to solve credit-related challenges faced by MSMEs. With new businesses and start-ups mushrooming across the country, NBFCs are developing technological edge to analyse borrowers business data and gauge financial health of the prevailing and future businesses.

Auto Loans Financing

According to India Ratings, the domestic automobile is expected to witness an annual growth of 5 to 9% in sales volume for 2022-23 - following three consecutive years of a declined growth rate. This would be driven by an intermittent improvement in consumer sentiments and continued preference for personal mobility. There exists challenges amidst risks of supply chain disruptions and shortage of semi-conductors. Growth in sales of commercial vehicles would be driven by improvement in economic activities and infrastructure spending. The NBFCs enable vehicle financing to the remotest corners of the country.

Gold Loans Financing

The gold loan segment may record moderate growth in tandem with gold prices along with opening up of other financing avenues for borrowers.

Housing Loans Financing

According to ICRA, housing finance companies are likely to witness a portfolio growth of 9-11% in 2022-23, owing to increasing economic activity, lucrative interest rates and stability in property prices.

HUMAN RESOURCES

At SCUF, we continue to invest in the professional and personal well-being of our 27,997 employees. We are committed to creating a work environment that is diverse, inclusive, and positive, regardless of gender, age, ethnicity and background. Even during the pandemic, we proactively adopted work-from- home while also providing basic and necessary infrastructure to our employees.We took various measures to provide a safe work environment on resumption of working from office. This included implementation of flexible work arrangements, use of video conferencing platforms, cleansing, disinfecting and sanitising measures at premises. We quickly adapted to technological changes, market changes and expectation of our customers. It is vital that our employees stay abreast of the latest industry developments and be future-ready. We conducted several workshops and seminars to align our employees with the rapidly changing business environment. This has allowed us to set long-term growth objectives and build career growth plans for every individual associated with the organisation. Company continues to ensure employee- friendly policies for smooth working.

RISK MANAGEMENT

At SCUF, risk management forms the centre of our business strategy. We aim to consistently protect the interest of our customers, colleagues, shareholders, and the Company, while ensuring a sustainable growth. This is achieved through informed decision-making and robust risk management, supported by a consistent risk-focused culture. Our risk management framework is structured to align with the industry-accepted internal controls framework and standards. The maintenance of a strong control framework is of high priority and forms the foundation for the delivery of effective risk management. The Company is committed to ensuring its risk management practices reflect a high standard of governance, enabling the Management to effectively undertake prudent risk-taking activities. Our framework and de-risking policies are supported by standards, guidelines, processes, procedures, and controls that govern day-today activities in the Companys businesses. These policies are reviewed and approved by the Board Committees and the Senior Management. It encompasses independent identification, assessment, and management of risk across businesses verticals. The comprehensive risk management policies and processes help in identification, evaluation, and management of business risks, effectively. The Risk Management Committee has identified and categorised major risk classes encompassing Credit, Market, legal and regulatory, operational, liquidity, interest rate, cyber security and information technology risks, strategic risk, economic risk among other significant risks.

OUR RISK MANAGEMENT FRAMEWORK

KEY RISKS AND MITIGATION

Risk Type and Definition	Mitigation
Credit Risk	• With over three decades of experience, the Company manages credit risk through strict credit norms and with robust procedure.
The risk of potential loss arising from the failure of borrowers and/or counterparties to meet their contractual obligations. The Company is exposed to credit risk from the lending activities.
	• We implemented a robust credit appraisal process for all business segments, simultaneously putting in place commensurate risk mitigation practices.
	• We implemented underwriting of borrowed capital, keeping in mind the inherent cash flows of the customers and by taking effective inputs from credit bureaus information reports.
	• We undertake regular stress testing and scenario analysis of the entire credit portfolio to implement corrective actions.
	• We use defined credit ratings from established credit rating agencies as mandated by our process, to make portfolio investment decisions with systematic tracking of the portfolio.
	• We take appropriate risk exposures through rigorous analysis of the counterparty fundamentals, industry, and sectoral risks.
	• We ensure portfolio risk concentration through implementation of prudent allocation strategies across different asset classes, industry sectors, geographical regions, single liability, and joint liability groups.
Market Risk	• The Companys market risk management is governed by a set of framework, policies and processes that are subject to regular reviews to ensure overall relevance to the current market practices and regulatory guidelines.
The risk surrounding earnings and capital, arising from changes in the interest rates, credit spreads, foreign exchange rates, commodity prices, among others.
	• We implemented the Asset Liability Management Committee (ALCO) for frequently monitoring market movements, Government policy decisions, changes in regulatory scenario affecting the NBFC space, and tweak the strategies accordingly. Thereon, operationalising in a prudent and timely manner.
	• We proactively monitor the market risks and accordingly de-risk loan book portfolio through a well-organised Market Risk Management System.
	• We periodically simulate impact arising from sudden market shocks, through rigorous stress testing of the portfolio across asset classes.
Operational Risk	• The Company has an operational risk framework in place that assists all departments to achieve their objectives through the effective identification, assessment, measurement, control, and mitigation of risk.
The risk of loss resulting from inadequate or failed internal process, people, systems, organisation, regulatory and internal compliance or from external events.
	• Our state-of-the-art corporate governance practices, code of conduct, corporate ethos and organisation-wide approach for risk management are the pillars for mitigating operational risks.
	• We initiated need-based systematic reviews with regular updates to the internal controls and systems.
	• We initiated several systematic skill development programs and seminars to ensure organisation-wide standard and homogeneous potent workforce.
	• We have standard operating procedures and structure in place to ensure improved governance on transactions, portfolio assessment and regulatory compliance.
	• We enable risk-oriented audit procedures at systematic intervals across all departments to reduce enterprise risk exposure.
	• We conduct regular stress testing and audits of the Disaster Recovery (DR) plan and Business Continuity Plan (BCP), to assess the Companys preparedness against contingencies.
	• We ensure data security and data recovery through efficient contingency plans in place, against potential force majeure contingencies.
Interest Rate Risk	• The Company has put in place extensive policies and procedures to ensure that the assets and liabilities exposure are within the stipulated regulatory guidelines.
The risk arising from a financial loss, owing to unfavourable interest rates for both lending and treasury operations. It has a significant influence upon a companys net-interest income and profitability.
	• We enable rate-sensitive asset-liability maturity analysis to assess correlation of the loan book maturity profiles to interest rate fluctuations.
	• We set the interest spreads through categorisation of the entire gamut of assets and liabilities into several time-periods by synchronising them with contracted maturities or anticipated re-pricing dates. The difference between assets and liabilities maturity, or it being repriced at any time period, indicates the extent of exposure to the risk of potential changes in the margins on new or re-priced assets and liabilities.
Liquidity Risk	• The Companys liquidity risk management is governed by a set of framework, policies, and processes, as approved by the ALCO.
The risk that arises from the Companys inability to meet its financial obligations as and when the need arises/within predetermined timelines.
	• We adopted extensive range of liquidity risk management policies, procedures, and controls.
	• We manage liquidity in alignment to the Asset Liability Management (ALM) policies and operating procedures.
	• We created maturity ladder, and use of cumulative surplus/deficit of funds calculation technique on any specific maturity date, standardise determination of liquidity risk.
	• We have a contingency plan in place for liquidity management in case of crisis.
	• We proactively monitor capital adequacy and asset exposure levels, to assess potential funding requirements.
	• We created diversified source of funding including borrowings from banks, financial institutions, capital markets and public (fixed) deposits to facilitate flexibility in meeting funding requirements.
	• We ensure systematic cash management and asset-liability management training programs, to solidify the Companys financial position in the long-run.
Information Technology Risk	• We deployed state-of-the-art technology infrastructure and platform for processing of business information systems.
The risk arising as a result of IT infrastructural failure or data loss/threats causing operational setback and financial losses.
	• The Company has deployed efficient IT risk management mechanism with adequate measures, check, and controls.
	• We conduct systematic security drills and employee awareness programs.
	• We deployed Security Operations Centre (SoC) to secure IT infrastructure and network architecture on a 24x7 basis - identifying both internal and external threats, conducting disaster recovery drills in a systematic manner to achieve better Recovery Point Objective (RPO) and Recovery Time Objective (RTO) and undertaking rigorous security tests and evaluations prior to launching any application - to assure zero prospective loss to the customers or the organisation.
	• We regularly conduct vulnerability assessment and penetration testing, using internal resources and under the guidance of external experts.
	• We have drawn upon a contingency plan for rendering crucial business functions to customers, amid any functional section turning out to be non-functional at any point of time.
Cyber Security Risk	• The Company has deployed an effective and secure cybersecurity framework to manage threats.
The risk arising out of cyber-attacks and hacking, owing to increased usage of internet and digital means.
	• We safeguard critical assets from cyber-attacks through our 24X7 Security Operations Centre (SoC)
	• We have systematically invested in installing state-of-the-art security system and hired professionals to ensure highest standards of preparedness against any cybersecurity threat.
	• We established security framework, policies and procedures aligned with best-in-class industry standards to protect information across all strata of the organisation.
	• We conduct all-inclusive security training programs and workshops for higher awareness on cyberattack incidents, such as malware, phishing, ransomware, spoofing, and more.
	• We procured ISO 27001 certification for Information Security Management System framing policies and procedures, on IT framework, covering all IT processes.
	• We installed Email Threat Prevention (ETP) services to quarantine potential e-mail threats in advance.
	• We conduct regular penetration tests to assess vulnerabilities in the IT infrastructure and network.
	• We scrutinise fraud protection measures for authentication of risk-based transactions.

INTERNAL AUDIT

The Audit Committee and Risk Management Committee encompassing members from the Board of Directors appraises performance of the Internal Audit function of the Company which helps to effectively control and adhere to the regulatory compliance guidelines laid out depicting highest standards of governance followed in the Company.

The Internal Control System of the Company is proportionate to its size, scale, nature, and complexity of operations. The Company conducts its internal audit within the parameters of regulatory framework through execution of annual internal audit plan. The Internal audit department carries out specific assessments laid by the management under existing regulations to monitor adequacy, efficacy and adherence to the internal controls, processes, and procedures. This helps in conservation of Companys assets.

The Company adopts Risk-based approach of Internal Audit (RBIA). The vital focus of this system is to focus on key risk areas of importance with main emphasis on risks that has extensive impact.

The Internal Audit department reports to the Audit Committee for Audit Planning & Reporting. The relevant audit reports are circulated to the management teams and the Audit Committee of the Board. The Audit Committee regularly reviews the audit findings as well as the adequacy and effectiveness of the internal control measures.

INTERNAL CONTROL OVER FINANCIAL REPORTING

Company has in place an effective internal control system to synchronise its business processes, operations, financial reporting, fraud control, and compliance with extant regulatory guidelines and compliance parameters. Strict internal control and systems are devised as a depiction of the principles of the highest standards of governance. The Company ensures that a standard and effective internal control framework operates throughout the organisation, providing assurance about safekeeping of the assets and execution of transactions as per the authorisation in compliance with the internal control policies of the Company. This confirms orderly and effective conduct of its business, including adherence to the Companys policies, accuracy and completeness of the accounting records and timely preparation of reliable financial information. The internal financial controls with reference to the financial statements were adequate and operating effectively.

The Management periodically reviews the framework, efficacy, and operating effectiveness of the Internal Financial Controls of the Company, broadly in accordance with the criteria established under the Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organisations of the Treadway Commission ("COSO").

CAUTIONARY STATEMENT

Statements made in this Management Discussion and Analysis Report may contain certain forward-looking statements based on various assumptions on the Companys present and future business strategies and the environment in which it operates. Actual results may differ substantially or materially from those expressed or implied due to risk and uncertainties. These risks and uncertainties include national and global effect of economic conditions, political conditions, volatility in interest rates, changes in regulations and policies impacting Companys businesses and other related factors. The information contained herein is as referred. The Company does not undertake any obligation to update these statements. The Company has obtained the data and information referred here from sources believed to be reliable or from its internal estimates, the accuracy or completeness of which cannot be guaranteed.