Banks to recoup market share as high rates, tighter liquidity hit NBFCs

The recent rise in interest rates and tighter liquidity in the bond market after the default by Infrastructure Lending & Financial Services (IL&FS) is likely to tilt the balance in favour of banks. A steady decline in 10-year government bond yields beginning the second half of 2014 led to a sharp decline in borrowings costs for non-bank lenders, improving their competitiveness against commercial banks that rely on low-cost deposits. 

The average cost of borrowings (or cost of funds) for listed retail lenders declined from a high of 10.13 per cent in FY13 to a decade low of 8.21 per cent in FY18. The decline was even sharper for non-bank finance companies (NBFCs), excluding Housing Development Finance Corporation (HDFC), as the cost of funds declined to a decade low of 8.6 per cent (on average) in FY18, from a high of 10.6 per cent in FY13. 

As a result, the spread between the cost of funds of NBFCs (ex-HDFC) and of banks declined to a decade low of 3.39 per cent in FY18 on average, from 4 per cent in FY14.  In the same period, their margins (excess of yields on advances over cost of funds) expanded to 760 basis points in FY18 from 650 basis points in FY14, on average. In comparison, banks’ margins were stable at around 6.9 per cent during the period.

 

The result was a virtual explosion in retail lending by NBFCs such as HDFC, LIC Housing Finance, Bajaj Finance, Indiabulls Housing, and Dewan Housing Finance. In the last three years, the combined lending by listed retail NBFCs grew at a compound annual growth rate (CAGR) of 19.5 per cent, against 7.6 per cent annualised growth reported by banks during the same period. 

The analysis is based on the audited finances of listed retail NBFCs that are part of the BSE500 index. The Business Standard sample includes 21 NBFCs. In banks, 37 listed public sector (PSBs) and private lenders were included.  

Given its large size and superior balance sheet, HDFC is an outlier in the NBFC space, with cost of funds being closer to banks rather than other non-bank lenders. For example, HDFC’s cost of funds were 116 basis points lower than what other retail NBFCs paid on average, and only 52 basis points higher than banks’ average cost of funds in FY18.

Analysts expect the cycle to shift in favour of banks as the rise in interest rates will push up NBFCs’ borrowings, thus bringing down margins. “Unlike banks, NBFCs largely rely on market borrowings to fund their operations. The rise in yields and tight liquidity conditions will push up their borrowings cost, resulting in lower margins and a slowdown in loan growth," says G Chokkalingam, founder and MD of Equinomics Research & Advisory Services.

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The worst hit will be those operating with high leverage and low capital adequacy. For example, five housing finance firms in our sample had relatively high debt-equity ratio of 10X or more during FY18, making them susceptible to the volatility. The loan book of NBFCs in our sample jumped to Rs 9.2 trillion at the end of March from around Rs 4.5 trillion at end of March 2014. In the same period, banks’ combined loans expanded from Rs 60.3 trillion to Rs 82.5 trillion. The result was a steady decline in banks’ share of the country's overall lending pie during the period. 

Analysts now expect banks to recoup some market share loss, thanks to recent developments. "Banks with access to low-cost deposits have a cost advantage over NBFCs in a rising interest rate scenario, but gains will largely flow to large private sector banks that have capital to grow their loan book. Public sector banks with poor capital adequacy may still lose market share," said Dhananjay Sinha, head of research, Emkay Global Financial Services.