NBFC Sector Update -Diversified Financials By Kotak Institutional Equities
A breather
The RBI’s reversion of risk weights for bank lending to NBFCs will likely encourage the flow of bank credit to the sector, thereby improving the liquidity for smaller players and the bargaining power of larger players for better rates. The sharp slowdown in bank funding to NBFCs and consistent MCLR hikes by banks imply a slower rate transmission, posing a risk of NIM downgrades. This risk is now lowered.
RBI has reverted to standard risk weights for bank loans to NBFCs
In November 2023, the RBI had increased risk weights for bank lending to NBFCs by 25 bps (over and above the risk weight associated with the given external rating). This followed the RBI’s concerns about risk build-up in certain segments of consumer credit and increased dependence of NBFCs on bank borrowings. Notably, housing loans, educational loans, vehicle loans, loans against gold and microfinance/SHG loans were excluded from the aforementioned hike. Thus, the higher risk weights weighed on the cost of funding for NBFCs engaged in non-PSL, personal/consumer and other unsecured, with lower impact of vehicle finance NBFCs or HFCs. The RBI has now (February 25, 2025) reverted to the original (down by 25 bps) risk weights. This, in our view, will improve funding access to all NBFCs and particularly more to NBFCs in non-PSL, personal/consumer and other unsecured that faced the heat of higher risk weights. Exhibit 1 shows the calculated cost of funds for non-banks under coverage. On a yoy basis, the cost of funding for Bajaj Finance and LT Finance has increased higher than the rest. HFCs’ 20-40 bps yoy increase reflects a lower share of lowcost NHB funding, apart from an increase in MCLRs by banks
Sharp decline in bank funding to NBFCs has been concerning
Following the RBI advisory and November 2023 increase in risk weights, bank funding to NBFCs has slowed down. Exhibits 2 and 3 show that yoy growth in bank funding to NBFCs reduced to 5-7% from 15-22% a year back. While most NBFCs under coverage have not faced any liquidity challenges, smaller unlisted players with high unsecured exposures have significantly diversified funding sources. In the meanwhile, banks continue to focus on margins and raise MCLR rates. Banks have raised MCLR by 15 to 40 bps in 1HFY25; some banks raised MCLR marginally (5 bps) this month as well (Exhibit 4).
In a somewhat better place
The NBFCs that we hosted at our CG2025 conference early this month highlighted that the cost of funding remains sticker-than-expected with banks going slow in rate cut transmission. This, coupled with the pressure on yields, reflecting the shifting mix or lower fee/insurance income, puts our margin estimates at risk. Further, the RBI, in a recent draft, has proposed to remove foreclosure/prepayment charges on all floating rate loans. The current regulations do not permit prepayment/foreclosure charges on floating home loans. The RBI’s move to restore risk weights to lower levels reduces this downside risk to margins.
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