NBFC's mission to diversify funding may see them struggle in the quest

In 2009, Tata Capital’s Rs 500 crore bond issue was subscribed a tad over six times; the non-banking financial company (NBFC) retained Rs 1,500 crore. “We feel such bonds will become an instrument of choice for investors and other corporates, leading to the development of a strong corporate bond market,” said Praveen P Kadle, then managing director (MD) of the firm. A decade and half later, Mint Road has made it clear that banks will have to diversify their funding sources (tap the bond market) rather than rely on bank finance. It upped the risk weights on bank exposures to NBFCs by 25 percentage points last November.
 

The Financial Stability Report (FSR, December 2023) had drawn attention to bank lending to NBFCs – it made up for 9.9 per cent of total bank credit (end-June 2023); and increased at a compounded annual growth rate of 26.3 per cent in the past two years (from June 2021 to June 2023). This was well above the growth rate of 14.8 per cent in bank credit.
 

“Bankers are the largest lenders to NBFCs and credit growth is likely to slow down in FY25. Apart from direct lending, they also invest in debt papers and securitisation transactions of NBFCs,” says Karthik Srinivasan, senior vice-president and group head (financial sector ratings), ICRA. Assuming banks continue to hold the share of credit to the sector (as a percentage of overall credit) at current levels (9.4 per cent), incremental direct lending by them could be constrained at Rs 1.7-1.9 trillion for FY25.

This would be about 33 per cent of the total base case incremental funding requirements of the sector (Rs 5.3-5.5 trillion) in FY25, vis-à-vis having met an estimated 38 per cent of incremental funding requirements in FY24 via direct lending.

 

Bond route
 

Arka Fincap’s Rs 300 crore bond issue (of two-, three- and five-year tenures) was the first to test the market after Mint Road’s risk-weight hike. The firm, a subsidiary of Kirloskar Oil, is only five years old and small (assets of around Rs 5,000 crore with an “AA” rating), and the float was closely watched. The bond issue sailed through. While it may be argued that the RBI’s diktat was aimed mostly at the top-rated NBFCs with close to 80 per cent share of bank credit extended to this business, it does not mean others will find the going smooth when it comes to bonds.
 

Y S Chakravarti, MD and chief executive officer (CEO) of Shriram Finance, believes that the “appetite for NBFC bonds will be selective. A lot will depend on the rating and business models, especially after the increase in the risk weightage”. RBI Deputy Governor, M Rajeshwar Rao may well have a made a reference as to where the game is headed. In a speech to the Confederation of Indian Industry in February 2024, he said some NBFCs have concentrated exposure to segments like consumer and vehicle loans. “If any of these segment faces economic stress, there can be significant impact on the financial of those NBFCs and, in turn, on their lenders including banks.”
 

“There are two principal ways you can go about raising non-banking debt. Either you increasingly tap the bond markets or sell down your assets. But not many can tap the capital market due to various constraints,” says Vimal Bhandari, executive vice-chairman and CEO at Arka Fincap. What he adds is worth pondering: “As for sell-down of assets, having done it, how do you re-grow? I think business models will have to be rethought in many cases.”
 

“Product diversification will be a key agenda for NBFCs whose core competence lies in the ability to reach, underwrite and cater. The diversification is expected to be through a mix of organic, inorganic and partnership routes,” feels Krishnan Sitaraman, senior director and chief ratings officer at CRISIL Ratings.
 

Apart from direct lending, banks are also one of the key subscribers of debentures and commercial papers (CPs) of NBFCs. A paper by Abhyuday Harsh, Nandini Jayakumar, Rajnish Kumar Chandra, and Brijesh P (in the RBI’s Department of Economic and Policy Research) in Mint Road’s September 2023 Bulletin observed “in this way, their (banks) exposure to NBFCs is higher than the quantum indicated by direct lending”.
 

Is this to convey that banks’ direct lending to NBFCs, subscription to their bonds and CPs are to be taken together from here on while calculating exposure to the sector? As in, form-factor differences are to be set aside: Loan  versus investment book of banks (bonds and CPs fall under the latter category). What complicates the picture is that “banks and NBFCs have entered into various co-lending models with divergent underwriting practices and banks have been the major lenders to NBFCs, rising interconnectedness raises risks emanating from cross-sectional dimensions”, as the December FSR noted.

 

Go, diversify
 

While diversifying their funding sources, Mint Road has also shut the demand that top-layer NBFCs be allowed to raise deposits based on the argument that there is little difference in the way they are regulated compared to banks. Rao was blunt: "…let me emphasise that it is indeed the non-acceptance of public deposits by NBFCs which provides the regulatory comfort to the Reserve Bank to have lower entry barriers for NBFCs, allow them to specialise in any specific sector of their choice and have lower exit barriers to wind up their businesses”.
 

Mint Road’s nudge to NBFCs to diversify their funding will change the game. NBFCs claim they have been caught off guard, but the issue was flagged by RBI Governor Shaktikanta Das with their corner-room occupants (and that of banks) in July and August 2023.
 

Paying more attention to Mint Road should be part of NBFCs’ risk culture.