NBFCs Likely To Face Margin Squeeze Of 25-40 bps Amid Rising Costs & Funding Challenges; Warns ICRA

Non-banking financial companies (NBFCs) in India are likely to encounter margin pressures in the coming quarters, driven by a combination of rising funding costs and operational expenses. According to a recent webinar conducted by ratings agency ICRA on August 21, the margins on loans against property (LAP) and unsecured loan books are projected to shrink by 25 to 45 basis points (bps), putting NBFCs under strain amidst an increasingly challenging economic environment.

The anticipated contraction in margins is a concern for NBFCs, which have traditionally relied on higher yields from their unsecured loan portfolios to bolster profitability. AM Karthik, Senior Vice-President and Co-Group Head for Financial Sector Ratings at ICRA, highlighted that this margin compression is primarily due to the expected increase in the cost of funds, coupled with the inherent slowdown in the unsecured lending space.

"We could see some compression in the margins of the LAP and unsecured book to the tune of 25-45 bps for the NBFCs. Further, there will be a slowdown in the unsecured book, which was earlier supporting yields and margins," Karthik explained during the webinar. This slowdown is anticipated to translate into a 20-40 bps rise in the cost of funds for non-bank financiers, further squeezing their margins.

Manushree Saggar, Senior Vice-President at ICRA, echoed these sentiments, noting that the pressure on margins is unlikely to ease anytime soon. She pointed out that both the cost of funds and operational expenses for shadow banks are expected to remain elevated, exacerbating the challenges for NBFCs. This dual pressure of rising costs and slowing loan growth is likely to erode the profitability of NBFCs, which have been a crucial part of India's financial ecosystem, especially in serving underbanked and underserved segments.

Despite the challenges, some NBFCs have sought to boost their unsecured loan portfolios through strategic partnerships. In recent developments, L&T Finance announced a tie-up with fintech major CRED on August 20 to offer unsecured personal loans. Similarly, Tata Capital and Lendingkart partnered the following day to co-lend unsecured business loans to micro, small, and medium enterprises (MSMEs). These partnerships are aimed at enhancing their lending capabilities and tapping into new customer segments, even as the broader market shows signs of cooling.

However, while these collaborations may offer some respite, they are unlikely to fully offset the broader margin pressures facing the sector. The slowdown in unsecured lending, coupled with rising funding costs, suggests that NBFCs will need to explore alternative avenues to maintain profitability.

In addition to margin pressures, NBFCs are also expected to face challenges in securing adequate funding to support their growth ambitions. ICRA highlighted that the availability of funding could become a significant impediment to growth, particularly as banks become more cautious in their lending practices towards shadow banks. The Reserve Bank of India (RBI) has previously expressed concerns about banks' aggressive lending to NBFCs, which has led to a tightening of credit availability from traditional sources.

As a result, NBFCs may increasingly turn to capital market instruments such as non-convertible debentures (NCDs) and external commercial borrowings (ECBs) to meet their funding needs. ICRA noted that the growth of assets under management (AUM) for NBFCs is likely to decelerate to 13-15% in FY2025, down from 18% in the previous fiscal year. "Key challenges for meeting growth expectations, however, would be in accessing the required debt funding over and above the refinancing of existing debt," the agency stated.

The outlook for NBFCs remains clouded by a combination of external and internal challenges. The anticipated margin contraction, rising funding costs, and slowing loan growth all point to a more challenging operating environment for these financiers. While strategic partnerships and capital market instruments offer some avenues for growth, they may not be sufficient to counterbalance the headwinds facing the sector.