RBI paper says monetary policy transmission to NBFCs remains incomplete

RBI research shows incomplete transmission of policy rates to NBFCs as higher borrowing costs, risk perception and reliance on banks and markets dampen rate adjustments

Empirical analysis shows that monetary policy impulses are transmitted to NBFCs’ borrowing and lending rates, albeit incompletely, according to a research paper published in the RBI Bulletin. On the borrowing side, a key impediment to transmission could be the higher cost of funds faced by NBFCs.

 

NBFCs rely on bank and market borrowings for funding requirements and, unlike banks, do not have direct access to the liquidity adjustment facility (LAF) window, the research paper noted. Consequently, reductions in the repo rate may not immediately translate into reduced cost of funding.

 

Further, bank and market funding to NBFCs depends on liquidity conditions and perceived riskiness, which may further dampen transmission, the research highlighted.

   

A change in policy rate affects NBFCs via their cost of funds, which moves when market and bank interest rates respond to monetary policy.

 

“On the lending side, since NBFCs cater relatively to riskier borrower segments, they charge higher interest rates to account for potential defaults, which may further dampen adjustment of lending rates to changes in relevant rates,” the paper mentioned.

 

On the borrowing side, a one-percentage point change in the repo rate is associated with a 0.24 percentage point change in the weighted average borrowing rate (WABR) of NBFCs over three quarters. Larger and more profitable NBFCs can borrow at lower rates. Meanwhile, a one-percentage point change in the repo rate is associated with a 0.33 percentage point change in the weighted average lending rate (WALR) of NBFCs over three quarters.

 

Overall, asset quality in the sector has improved in recent years, with a consistent decline in NPA ratios. At end-December 2024, GNPA and NNPA ratios stood at 3.4 per cent and 1.2 per cent, respectively.

 

The credit portfolio of NBFCs is dominated by loans to industry and retail segments, constituting around 72 per cent of total outstanding credit. Retail loans have been growing in double digits, but weakness in industry and services has contributed to moderation of overall credit growth. Still, credit growth in both segments remains in double digits.

 

NBFCs primarily raise funds from markets and banks, which accounted for 38.7 per cent and 37.4 per cent of their total borrowings, respectively, at end-December 2024. Apart from the domestic market, NBFCs are increasingly turning to external commercial borrowings (ECBs). The share of NBFCs in total ECB registrations has been rising, with borrowings via ECBs up 43 per cent in FY25 from 27.2 per cent in FY24.

 

The paper also emphasised that NBFCs must remain vigilant and proactively address cyber challenges by leveraging new opportunities effectively as the financial sector adopts artificial intelligence.