A, BBB-rated NBFCs face sharper slowdown amid asset quality stress

Lower-rated NBFCs face increased credit cost, lagged funding relief and rising losses in unsecured segments as overall loan growth slows down, says India Ratings

Lower-rated non-banking financial companies (NBFCs) -- ‘A and BBB’ rated -- are tackling a greater slowdown across segments and asset classes compared to their larger peers, and a relief due to recent repo rate cut will reach them with a lag, said India Ratings.

 

Due to asset quality stress, elevated funding cost, and slowdown in partnership and co-lending business, NBFCs have become cautious, resulting in a decline in the pace of disbursements, the ratings agency said.

 

Segments such as microfinance institutions (MFIs), gold loans and unsecured loans (personal and business) have witnessed a steep fall in the growth rate.

 

Karan Gupta, Head and Director Financial Institutions, Ind-Ra said, “As the overall NBFC segment loan growth slows down, the impact for ‘A and BBB’ category rated entities is higher due to the challenges resulting from asset quality stress, an elevated funding cost, and a slowdown in the partnership and co-lending businesses.” 

 

The rating agency said that the funding cost has remained elevated for the sector, however, the recent cut in the repo rate would provide some relief with a lag.

 

It highlighted lower rated NBFCs mainly rely on banks and larger NBFCs for their funding needs, and funding from the capital markets, where the transmission of rates would be faster, is close to negligible.

 

As they mainly rely on banks for their funding, the benefits of a softening in rates is passed on to them with a lag.

 

Further, due to overleveraging at the borrowers’ end, especially in the unsecured loan segment, there has been an increase in the credit cost across classes. 

 

The extent of rise in the credit cost in the unsecured lending space is such that the entity could make losses, thereby depleting the capital buffers.

 

According to Ind-Ra, the provision coverage ratio especially for unsecured lenders is still below the prudent levels and the entities need to increase these gradually, which will keep profitability under pressure till the catch up happens.

 

Also, there are instances of covenant breaches for some entities which lead to either an increase in borrowing cost or a restriction on further borrowing. This affects the portfolio expansion and profitability. 

 

As a consequence of a slowdown in overall NBFCs growth, the profitability has been under pressure.

 

There was a revival in profitability in the 2022-2023 and 2023-2024 post the pandemic.

 

However, the weak operating performance of MFIs and unsecured lenders led to a compression in profitability 2024-2025.