NBFCs face a perfect storm of consolidation, capital raising, and profitability pressures in 2024

The downhill journey of non-banking finance companies (NBFCs) began with the IL&FS crisis, a large infrastructure financing company that succumbed to asset-liability mismatches in 2018. The tighter liquidity, risky business models and asset-liability mismatches also affected other major NBFCs such as DHFL, Reliance Capital, and SREI.

Confronted with the risk of a spillover effect in the financial services industry, the Reserve Bank of India (RBI) is now taking no chances. The regulator has responded by tightening regulations and intensifying scrutiny of NBFCs in the last couple of years. These changes aim to address governance issues, strengthening risk management practices, and ensure higher level of supervision.

According to a recent RBI report, the Department of Supervision will focus on examining licensing requirements for NBFCs and initiating supervisory actions against non-compliant NBFCs in the fiscal year 2023-24. The year 2023 saw many regulatory changes impacting the business model of NBFCs.

The challenges plaguing the NBFC sector extend well into 2024. Experts are talking of consolidation, capital raising, and profitability pressures in 2024.

Let's delve into some of the new regulatory changes and their potential impact on the NBFC landscape in the coming years.

Last month, the RBI tightened norms related to unsecured lending portfolios of banks and NBFCs due to indiscriminate growth in the unsecured loan portfolio, especially in personal loans and credit cards. Risk weights have been raised by 25 basis points to 125 per cent on retail loans.

What does this mean for NBFCs? It implies higher capital allocation for underwriting unsecured loans, thereby pressuring capital levels. Raising capital at this juncture could also impact valuations, as investors exercise caution given the high growth in the unsecured portfolio. With interest rates already at peak levels, any geopolitical shocks may hinder the anticipated interest rate softening in 2024.

Gautam Jain, Chief Business Officer, Vivriti Capital admits that while the ongoing funding winter may have hindered capital-raising efforts, but the capital is available for proven business models generating positive cash flows.

"We anticipate that credit demand in the sector will continue to grow as inflation subsides (already hovering around the tolerance band) and interest rates stabilize in the next 6 to 9-month cycle. The increased risk weight for NBFC loans under the new RBI regulations will raise borrowing costs for NBFCs, however, the impact could be short-term in nature as NBFCs will be able to adjust their lending rates accordingly, "says Jain.

The RBI has also imposed restrictions on banks' lending to NBFCs by increasing risk weights. This move is aimed at safeguarding banks' balance sheets, considering the aggressive lending by banks to NBFCs in recent years. Banks have been increasing their unsecured lending while also indirectly taking exposure to risky assets through NBFC lending. This includes lending to fintech NBFCs by relying on algorithms and extending credit to new borrower categories which lack credible credit history.

In a recent directive last fortnight, the RBI has introduced guidelines for banks and NBFCs lending to Alternative Investment Funds (AIFs) with dual exposure to a specific entity.  Banks and NBFCs are now restricted from investing in AIF schemes that have investments, either directly or indirectly, in their existing borrower company.

Arun Nayyar, MD & CEO, NeoGrowth says that the growth of the NBFC ecosystem will be driven by strong risk and governance mechanisms. "With the integration of technology, NBFCs with responsible lending practices, creating a positive impact, will lead the way, "says Nayyar.

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