NBFCs need to further diversify funding sources to mitigate risk: RBI

Reduction in NBFCs' reliance on banks for funds bodes well for financial stability, RBI says

Non-banking financial companies (NBFCs) need to further diversify their sources of funding as a risk mitigation strategy, as their dependence on banks remains high despite some moderation in recent times, the Reserve Bank of India (RBI) has said in a report.

 

Apart from direct lending to NBFCs, banks also subscribe to debentures and commercial papers (CPs) issued by NBFCs. “With a decline in subscription to debentures by banks, overall banks’ exposure as a share of NBFCs’ borrowings moderated from 43.1 per cent at end-March 2023 to 42.7 per cent at end-March 2024”, said the report titled ‘Trend and Progress’. 

 

 

“The reduction in NBFCs’ reliance on banks for funds bodes well for overall financial stability”, the RBI said in the report, adding that bank borrowings remain the primary source of funds for NBFCs. 

 

Following the Infrastructure Leasing & Financial Services (IL&FS) crisis, the NBFCs sector faced liquidity challenges as erosion in confidence, and rating downgrades limited their borrowing capability from the market and increased their reliance on banks. This was further exacerbated during the pandemic.

 

The growing dependence on bank funding raised regulatory concerns, prompting the RBI to increase the risk weight for banks funding NBFCs from 100 per cent to 125 per cent in November 2023. This has resulted in moderation in reliance on bank funding.

 

NBFCs are increasingly looking towards the domestic debt capital market to raise funds as bank funding has slowed down. While NBFCs with better ratings have tapped the debt capital markets and raised funds through bonds and commercial papers, few have also taken the international route and tapped the overseas bond market to raise substantial amounts. Additionally, many are also utilising the securitisation market to raise money to fund their growth.

 

The report highlighted that funds mobilised by NBFCs through the issuance of non-convertible debentures (NCDs) increased in 2023-24, with more than 80 per cent of issuances being highly rated – AAA or AA. Additionally, borrowing by NBFCs via CPs also increased in 2023-24, the report said.

 

The report also highlighted that growth in secured borrowings of NBFCs decelerated during 2023-24, while unsecured borrowings picked up on the back of market borrowings – through the issuance of debt instruments, viz., debentures and commercial papers. Across layers, the NBFC-middle layer mobilise more unsecured funds mainly because of the presence of government NBFCs.

 

The RBI has cautioned the NBFC sector against a ‘growth at any cost’ approach, saying it would be counter-productive, and a robust risk management framework should be implemented. The central bank has also suggested that the shadow banks need to strengthen their initiatives to address customer grievances, adhere to fair practices and avoid recourse to usurious interest rates so as to ensure their relevance in a fast-changing financial landscape.

 

In October, RBI barred four NBFCs, including two microfinance institutions (MFIs), from sanctioning and disbursing loans for charging exorbitant interest rates to the borrowers. The action was based on material supervisory concerns observed in the pricing policy of these companies in terms of their weighted average lending rate (WALR) and the interest spread charged over their cost of funds, which were found to be excessive and not in adherence with the regulations. 

 

The RBI has also highlighted in the report that the NBFCs should be mindful of the evolving concentration risk and climate-related financial risks associated with credit to certain sectors, besides being watchful of cybersecurity threats.

 

Meanwhile, the report has highlighted that key indicators of financial performance - return on assets (RoA) and return on equity (RoE) - for NBFCs improved during 2023-24 across all layers and classifications of NBFCs, benefitting from operational efficiency gains and effective risk management.

 

At an aggregate level, the NBFC sector achieved an improvement in both asset quality and capital adequacy during 2023-24. As of H1FY25, the gross and net NPA ratios of the NBFC sector declined to 3.4 per cent and 1.1 per cent, respectively. Additionally, during 2023-24, the balance sheet of the NBFC sector expanded in double digits (16.3 per cent as compared with 17.2 per cent in the preceding year). On the asset side, growth in loans and advances accelerated to 18.5 per cent in 2023-24 from 17.4 per cent in 2022-23, driven by upper-layer NBFCs. NBFC – middle layer’s credit growth was relatively muted on account of contraction in unsecured loans.