NBFCs may shed competitive edge as SEBI tightens rules to raise capital

Lesser regulatory intervention and flush of capital helped non-bank lenders outpace industry growth in the past

The Reserve Bank of India’s (RBI’s) observation that 8-13 per cent of non-banking finance companies (NBFCs) may not be able to comply with the tight capital adequacy framework let the cat out of the bag as the perception so far was that stringent norms shouldn’t affect their business. That assumption warrants some re-thinking given that working conditions are getting tight on all parameters, the most important being sourcing of capital.

Market regulator the Securities and Exchange Board of India (Sebi) reducing the sectoral exposure of mutual funds to NBFCs, including housing finance companies, from 40 per cent to 30 per cent, apart from mandating them to participate in commercial papers and non-convertible debentures, all of which are important capital raising instruments for NBFCs, would force the latter to rehash business strategies.

“The new regulations will reduce the leeway for NBFCs, especially in the backdrop of the recent Sebi regulation that prescribed large borrowers to raise 25 per cent of incremental borrowings from bond markets from FY22,” said Kotak Institutional Equities. 

To top it, the RBI’s financial stability report (FSR) published on Thursday mentioned that the dependence of NBFCs on banks for line of funding has risen from 21 per cent in March 2017 to 29 per cent in March 2019 and with this, the scope for further lending to NBFCs doesn’t appear very encouraging.

While capital is key to financial services sector, for NBFCs it was the availability of cheap capital which gave them the competitive edge over the rest, mainly banks. FSR states that with banks, including public sector banks now well-capitalised, could fill lending void created by NBFCs.

With a majority of stocks underperforming in the past 6–9 months, a part of this weakness is priced in. However, the uncertain aspect is the mutual funds tightening their purses, which takes away the possibility of liquidity normalising for NBFCs in the medium-term. The NBFC industry is set to adopt tighter asset-liability management (ALM) norms in less than a year from now, incremental cost of which was earlier pegged at 50–70 basis points (bps) in FY21. This may shoot up further by at least 100 bps if capital was to remain selective and expensive, say analysts.

“We believe incremental flows towards NBFCs will remain moderate and would come at borrowing cost. Market share gain for banks may continue at least in the near to medium term,” said analysts at Motilal Oswal Financial Services.