NBFCs To See Moderate Profitability In The Next 12-18 Months Due To Higher Funding Costs; Moody's Says

Higher funding costs may cause a modest slowing down in the profitability of Indian non-banking financial companies (NBFC) during the next 12 to 18 months, according to research released on Tuesday by rating agency Moody's. According to Moody's Ratings, loans at NBFCs would rise by around 15% over the stated span.

Recent events in the financial industry point to a significant change in market and regulatory dynamics that will affect both the personal lending and NBFC sectors. According to current projections, loans are expected to expand at an estimated 15% annual pace during 12 to 18 months. This might be a response to the RBI's order to secure more capital in case NBFC loans result in higher funding and borrowing costs.

The RBI projects that the Indian GDP will increase by 7% in FY25, which is in line with estimates from reputable international rating agencies that range from 6.5% to 7%. Strong consumer demand-particularly from retail consumers-is the main driver of this growth. increase in the BFSI industry is predicted to slow to 10-15% over the course of the next 12-18 months, which is less than the 20% increase that the top 20 NBFCs in the housing, automobile, and infrastructure finance sectors saw the year before. Funding channels to NBFCs have somewhat narrowed in response to the RBI's 25% rise in risk weightage in December and its warning against rapid expansion in unsecured lending.

Undoubtedly, the industries that an NBFC has historically served become more prevalent as an economy grows, which either lowers the margins for serving that industry or drives up costs. Generally speaking, these expenses climb on the demand side (i.e., loan servicing, collection reliability, etc.) when NBFCs pursue more challenging industries or clientele to serve. A supply-side spike in the cost of capital can put NBFCs under a lot of pressure in addition to demand-side cost hikes.

Dr. Ruchi Arora, Assistant Professor of Finance at Birla Institute of Management Technology (BIMTECH) said, "In November 2023, the Reserve Bank of India mandated an increase of the risk weights for consumer credit of commercial banks and NBFCs by 25 percentage points. However, this increase is limited to consumer credit only not to housing, education, gold, and vehicle loan. This will increase the cost of capital, possibly resulting in a rise in the cost of borrowing for borrowers if the cost is passed on to them. Increased expenses might potentially decrease interest margins, resulting in a marginal decrease in profitability. However, this move will safeguard the interests of the stakeholders and lead to sustainable financial stability."

Mr. Ajay Chaurasia, Vice President - Marketing, Product and Business, RupeeRedee said, "The cost of funding for NBFCs has indeed increased in recent years, largely because NBFCs rely heavily on borrowing from banks and other financial institutions rather than directly from consumers. Moody's report indicating a positive outlook for the industry is good news, suggesting that profitability can be maintained even as businesses scale up, thanks to healthy margins. The rise in credit demand from Indian consumers is also reshaping the lending landscape in India. This trend reflects growing consumer confidence and an increasing appetite for credit, which could drive further growth and innovation in the lending sector."

According to VLA Ambala SEBI RA and Founder of Stock Market Today, "Recent developments in our financial sector hint at a notable shift in regulatory and market dynamics whose repercussions are felt across NBFCs and personal lending segments. Current predictions highlight that Indian NBFCs could witness a moderation in profitability over the next 12-18 months, with loans growing at an estimated rate of 15% during the same period. This may be a reaction to RBI's mandate to set aside additional capital against loans to NBFCs, which inflated their funding cost and borrowing expenses. Such projected developments could trigger mixed cues in the investment landscape. While the inflated funding cost could lower profit margins and stunt loan growth, making NBFCs less lucrative for investors, the robust credit demand backed by economic growth could boost the sector's profitability and asset quality."

"In other words, the increased operating cost may decrease ROI but net income may remain sturdy. This would also stand true even if the interest rates soar and conditions around liquidity tighten. However, it should be noted that RBI's strict regulations for personal loans and credit cards directed at safeguarding consumer interest could slow down loan growth. Additionally, the regulatory body's new finance norms may affect core public sector NBFCs such as REC, IREDA, and PFC. Then again, from the investor perspective, such a situation could emerge as an opportunity to selectively invest in some quality NBFC stocks with strong financing standings and a history of withstanding funding crises," the analyst further added.

Utkarsh Sinha managing director Bexley advisors a boutique investment bank firm said, "NBFCs often serve as an arbitrage bridge to mainstream banking for hitherto unserved or underserved sectors: as a result, the business models that NBFCs adopt need to undergo rapid evolution to stay abreast of current and projected needs, as those needs evolve in a rapidly evolving economy. Naturally, as an economy matures, the sectors that an NBFC has traditionally served gain mainstream access, resulting either in a reduction in margins for serving that sector or an increase in costs. These costs usually rise on the demand side (that is, in terms of servicing loans, ensuring collections etc.) as NBFCs have to go after increasingly more difficult sectors or consumers to service. On top of demand side cost rise, a supply-side cost increase in the cost of capital can be a significant squeeze for NBFCs, which we expect to see in the market in the coming few years."

"The pathways for many NBFCs, naturally, tend towards full integration (that is, towards full banking - either through a license, or through acquisition): which leads us to postulate that we should see strong consolidators looking to lap up performing NBFCs as credit gets more expensive. Similarly, there will be a strong push towards innovation and FinTech as a tool for reducing demand-side costs and staying competitive amongst NBFCs, which means we can continue to see some equity funding in the space to bolster winners," commented Utkarsh Sinha on the outlook of NBFCs growth.

Jitendra Tanwar, Managing Director & CEO of Namdev Finvest said, "In the BFSI sector, growth is expected to moderate to 10-15% over the next 12-18 months, a decline from the previous year's approximately 20% growth observed among the top 20 NBFCs operating in infrastructure, housing, and automobile financing. Following the RBI's increase in risk weightage by 25% in December and its caution against high growth in unsecured lending, funding lines to NBFCs have tightened somewhat. While Namdev operates in the secured lending space and thus remains unaffected directly, the rise in credit costs has been observed across the finance industry due to a squeeze in systemic liquidity."

Regarding the profitability of the sector, Jitendra Tanwar added "It is anticipated that NIMs may contract for large NBFCs enjoying top ratings, despite robust demand facilitating the expansion of retail customer bases previously held by PSUs over the past decade. Lower-rated NBFCs operating in the secured space may still command spreads, especially if adequately funded with equity, thereby tapping into the prevailing credit gap in the market."

Macro events, such as stable interest rates in India amidst global rate hikes, along with stable rupee and oil prices, have provided additional comfort to NBFCs amid global uncertainties. Namdev has managed to reduce leverage through continuous equity rounds, minimizing exposure to short-term borrowings while strengthening ALM to mitigate any potential risks. With fixed-rate lending to MSME customers and a majority of debt also fixed-rate, the management feels well-equipped to navigate market fluctuations and safeguard profitability ratios, according to Jitendra Tanwar.

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