Mutual Funds Step In NBFCs As Sector Thrives Amid RBI Regulatory Changes; Funding Rises In 6 Months

The mutual fund industry's support for non-banking financial companies (NBFCs) has surged in the six months ending May 2024. This development follows the Reserve Bank of India's (RBI) decision to increase risk weightings on bank loans to NBFCs in November 2023.

According to data from CareEdge Ratings, reported by Business Standard, the total debt funds deployed in NBFCs through commercial paper and corporate debt increased from approximately Rs 1.6 trillion at the end of October 2023 to about Rs 2.1 trillion by the end of May 2024.

CareEdge Ratings data reveals that debt exposure to NBFCs, which includes commercial papers and corporate debt, rose by 22% year-on-year (Y-o-Y) to Rs 2.09 trillion. This exposure has maintained its position above the Rs 2 trillion mark for the second consecutive month, indicating a stable and significant investment trend in NBFCs.

The spike in mutual funds' (MFs') investments in commercial papers is noteworthy. In May 2024, MF exposure through commercial papers stood at Rs 1.15 trillion, a level last seen five years ago in May 2019. This consistent exposure above the Rs 1 trillion mark for six straight months reflects the growing reliance of NBFCs on mutual funds for funding.

The RBI's decision to hike risk weightings on bank loans to NBFCs by 25 percentage points in November 2023 has had a profound impact on the funding landscape. This regulatory change prompted banks to reassess their exposure to NBFCs, leading to a rise in mutual funds stepping in to fill the funding gap.

Bank loans to finance companies increased by 16% Y-o-Y to Rs 15.6 trillion in May 2024, up from Rs 14.76 trillion in October 2023, according to RBI data. In May 2024, mutual funds' debt exposure to NBFCs rose to 13.3% of banks' advances to NBFCs, up from 12.7% in May 2023.

CareEdge Ratings also noted a long-term trend where mutual fund exposure to NBFCs as a share of debt assets under management (AUM) reduced from nearly 20% in late 2018 to around 13% by May 2024.

As the sector continues to grow, the collaboration between NBFCs and mutual funds is expected to strengthen, providing a stable funding source that can support NBFCs' lending activities.

However, the sector must remain vigilant to potential regulatory shifts and market dynamics. The RBI's focus on ensuring financial stability and mitigating systemic risks means that NBFCs and their funding sources must be prepared.