Key Findings on NBFC Sector Performance
The Reserve Bank of India (RBI), in its “Trend and Progress of Banking in India 2023-24” report, emphasized the need for non-banking financial companies (NBFCs) to diversify their funding sources to reduce risks and enhance financial stability. Despite improvements in asset quality, profitability, and capital adequacy, the sector remains heavily reliant on bank borrowings.
Current Funding Trends
1. Bank Borrowings:
- Banks remain the primary source of funds for NBFCs, although their share in NBFC borrowings has reduced slightly from 43.1% in FY23 to 42.7% in FY24.
- The RBI’s decision to increase risk weight on bank funding for NBFCs from 100% to 125% in November 2023 has encouraged NBFCs to explore alternative funding sources.
2. Shift Towards Debt Markets:
- NBFCs with strong credit ratings are increasingly raising funds through non-convertible debentures (NCDs) and commercial papers (CPs).
- Over 80% of NCD issuances in FY24 were highly rated (AAA or AA).
- Borrowing via CPs also increased during the same period.
3. Securitization and Overseas Markets:
- Many NBFCs are leveraging the securitization market and raising funds through overseas bond markets, particularly those with better credit ratings.
Sectoral Growth and Performance
- Balance Sheet Expansion: The NBFC sector’s balance sheet grew by 16.3% in FY24, slightly below the 17.2% growth in FY23.
- Loans and Advances: Growth in loans and advances accelerated to 18.5% in FY24, driven primarily by upper-layer NBFCs, while middle-layer NBFCs experienced muted growth due to a contraction in unsecured loans.
- Profitability: Return on assets (RoA) and return on equity (RoE) improved due to operational efficiency and better risk management.
Asset Quality and Capital Adequacy
1. NPAs:
- Gross NPA ratio declined to 3.4% in H1FY25 from higher levels in previous years.
- Net NPA ratio reduced to 1.1%, reflecting improved asset quality.
2. Capital Adequacy: Increased across all NBFC layers, reinforcing the sector’s resilience.
Challenges and Risks
1. Concentration Risk: The report cautioned NBFCs about overexposure to specific sectors, which could pose systemic risks.
2. Climate-Related Risks: Credit exposure to climate-sensitive sectors requires careful monitoring.
3. Cybersecurity Threats: With increasing reliance on digital operations, the sector must remain vigilant against cyber risks.
4. ‘Growth at Any Cost’ Strategy: RBI warned against unsustainable growth approaches, emphasizing robust risk management frameworks.
Regulatory Oversight and Consumer Protection
The RBI has tightened its oversight of NBFCs:
- Action Against Violations: In October 2023, the central bank barred four NBFCs, including two microfinance institutions (MFIs), from disbursing loans due to exorbitant interest rates and non-compliance with fair lending practices.
- Fair Practices: NBFCs were urged to improve customer grievance redressal systems and ensure adherence to fair practices to maintain their relevance in a competitive financial ecosystem.
Recommendations for NBFCs
1. Diversify Funding Sources:
- Increase reliance on domestic and international debt markets.
- Tap into securitization and alternative instruments to reduce dependency on bank borrowings.
2. Strengthen Risk Management:
- Focus on addressing concentration risks and implementing effective cybersecurity measures.
- Avoid aggressive growth strategies that could jeopardize financial stability.
3. Adhere to Consumer-Centric Practices:
- Implement fair pricing policies and transparent communication with borrowers.
- Address customer grievances promptly and improve service standards.
Conclusion
The NBFC sector in India is showing resilience with improvements in asset quality, profitability, and capital adequacy. However, sustained growth depends on diversifying funding sources, adopting robust risk management practices, and maintaining consumer trust. As the sector navigates a fast-evolving financial landscape, the RBI’s recommendations will be pivotal in shaping its future trajectory.