How RBI Has Likely Put A Check On Unbridled Growth Of NBFC Profit Margins

Non-banking financial companies (NBFCs) have been enjoying their moment under the sun. For FY24, ratings agency ICRA said that AUM of NBFCs is expected to grow by 13-15 per cent, driven by strong retail portfolio. In FY23, their return on managed assets improved by 40 basis points to reach 2.8 per cent. Their net interest margins (NIM) increased by 58 bps yoy to 5.4 per cent in FY23, according to a Boston Consulting Group report.

To meet their high credit demand, NBFCs have turned to primary debt markets and banks. However, two RBI moves recently can have a bearing on the companies in the coming months.  

Recently, RBI has taken note of rising bank lending to NBFCs. The central bank noted in its bulletin that banks’ share in aggregate NBFC borrowings increased to 35.1 per cent in December 2022 from 29.7 per cent in December 2020. The bulletin noted, “Going forward, NBFCs need to diversify their funding sources, to reduce excessive reliance on bank borrowings.” 

The central bank’s decision to conduct open market sales of its bonds has also caused a stir in the bond market, with yields rising for issuers.   

With NBFCs expected to rely majorly on the debt market in the coming months, analysts expect an impact on the margins of these firms as the yields rise due to RBI’s decision.  

Rising Borrowings Rates 

Other than banks, NBFCs primarily raise funds from diverse financial instruments like corporate bonds, Commercial Paper (CP), etc.  

Earlier this month, India's 10-year bond yield saw its largest one-day increase in 17 months, reaching 7.3645 per cent. Rising bond yields are driving up borrowing costs for Indian NBFCs. RBI's recent OMO announcement prompted a 13-basis point increase in 10-year government bond yields, now standing at 7.34 per cent. 

Moreover, RBI's tighter control on liquidity has led to significantly higher interest rates for short-term commercial papers (CPs) as well. NBFCs have been most affected, facing a 40-basis point rise in rates for CPs with two to three months maturity since August, as per a report in Financial Express. 

''The Indian markets have shown resilience, but the global geopolitical headwinds may lead to higher inflation and result in tightening of the liquidity in the market. The recent fluctuation in the commercial paper rates was also primarily due to liquidity pressure in the market," says Gaurav Dixit, Director, BFSI Ratings, CareEdge Ratings. 

CLSA's June report highlighted that 20 per cent of NBFCs' bonds are maturing in FY24/25, with coupon rates below current levels, indicating potential refinancing issues. 

“Funding costs are expected to rise by 20 to 25 basis points due to the repricing of NCDs issued during the pandemic at lower rates. This may put pressure on margins,” says Jinay Gala, Research Analyst at India Ratings.  

Will It Impact Margins?    

There has been a strong contest in the lending space, which could affect margins, and NBFCs are countering this by increasing unsecured loans. As per India Ratings, the proportion of unsecured loans in the total assets under management increased to 30 per cent, up from 26 per cent in FY22 and 23 per cent in FY21.  

Gala says, the main concern is that borrowing costs will increase, which could put pressure on profit margins. These margins might stay around the same level, not necessarily declining, but they may plateau. The growing proportion of unsecured loans is something to keep an eye on because it's been increasing in the overall growth trend. 

“It’s still uncertain whether the increased focus on unsecured loans will significantly impact the margin pressures. There might be only a slight moderation in these pressures because the growth in unsecured loans is helping to support overall growth and offset the margin challenges,” he adds. 

Much of the growth in the NBFC sector can be attributed to the decline in delinquencies, boost in profitability and increase in the unsecured lending space. As per a report by TransUnion CIBIL, delinquency rates have decreased in all three major lending spheres (PSBs, NBFCs and Private banks), with NBFCs showing the most significant decline at 3.6 per cent. 

The surging demand for unsecured lending presents a dual-edged dilemma for the NBFC sector. On one hand, accommodating the expanding customer base and effectively handling the escalating volume is imperative to counterbalance margin constraints. However, on the flip side, RBI’s stringent approach to liquidity control could potentially challenge the sector, exerting upward pressure on borrowing costs. 

“NBFC’s earnings profile in H2FY24 is expected to remain strong driven by healthy credit growth, especially in the retail segment. However, with NBFCs continuing to be in expansion mode, the operating expense is expected to remain elevated, and with high competition and repricing of liabilities, the Net interest margins are expected to moderate in H2FY24. Nevertheless, driven by improving collection efficiency trends and recoveries, credit costs are expected to remain under control,” Dixit states. 

With the Q2 numbers of NBFCs trickling in, the picture of how the firms performed in H1FY24 is expected to become clearer. Analysts remain bullish on prospects of NBFCs for the entire year, with rating agency ICRA expecting a 13-15 per cent growth. However, the impact of cost of borrowings will be a thing to keep an eye on in the upcoming quarters.