The Trailing Plight of Non-Banking Finance Companies (NBFCs) Commenced with the IL&FS Crisis in 2018, where the large infrastructure financing entity faltered due to mismatches in asset-liabilities. This strain on liquidity, coupled with risky business models and similar asset-liability imbalances, also impacted other prominent NBFCs such as DHFL, Reliance Capital, and SREI.
Facing the potential domino effect in the financial services sector, the Reserve Bank of India (RBI) is taking proactive measures. The regulator has responded by tightening regulations and escalating oversight of NBFCs over the past few years. These measures intend to address governance concerns, fortify risk management protocols, and establish a more robust supervisory framework.
As per a recent RBI report, the Department of Supervision will concentrate on scrutinizing licensing prerequisites for NBFCs and initiating regulatory actions against non-compliant entities in the fiscal year 2023-24. The year 2023 witnessed numerous regulatory alterations impacting the operational structure of NBFCs.
The challenges besieging the NBFC realm persist significantly into 2024. Industry experts foresee a landscape characterized by consolidation, the need for capital infusion, and pressing profitability concerns throughout the year.
Exploring the Recent Regulatory Alterations and Their Potential Influence on the Future Landscape of NBFCs.
In the preceding month, the RBI enforced stricter guidelines pertaining to unsecured lending portfolios of both banks and NBFCs due to the rampant expansion in the unsecured loan segment, particularly in personal loans and credit cards. Risk weights on retail loans have been augmented by 25 basis points, reaching 125 per cent.
What repercussions does this hold for NBFCs? It signifies an increased necessity for capital allocation in order to underwrite unsecured loans, thus exerting pressure on existing capital levels. The act of raising capital at this stage might also impact valuations, as investors approach with caution due to the rapid growth observed in the unsecured portfolio. Furthermore, with interest rates already peaking, potential geopolitical disturbances could impede the projected softening of interest rates in 2024.
Gautam Jain, Chief Business Officer at Vivriti Capital, acknowledges that despite the ongoing challenges in acquiring funds, capital remains accessible for established business models that demonstrate positive cash flows.
We foresee a surge in credit demand within the sector as inflation gradually diminishes (already nearing the tolerance range) and interest rates stabilize over the forthcoming 6 to 9 months. The augmented risk weight for NBFC loans due to the new RBI regulations will escalate borrowing expenses for NBFCs. Nevertheless, the potential repercussions might be transient in nature as NBFCs will have the capability to recalibrate their lending rates accordingly," explains Jain.
The RBI has further imposed limitations on banks' lending to NBFCs by heightening risk weights. This action aims to shield banks' balance sheets, considering the aggressive lending practices to NBFCs in recent times. Banks have been amplifying their unsecured lending while indirectly exposing themselves to risky assets through NBFC lending. This encompasses lending to fintech NBFCs through reliance on algorithms and extending credit to novel borrower segments that lack reliable credit histories.
In a recent directive issued in the last fortnight, the RBI has introduced guidelines for banks and NBFCs engaging in lending to Alternative Investment Funds (AIFs) that possess dual exposure to a particular entity. Banks and NBFCs are now prohibited from investing in AIF schemes that have direct or indirect investments in their existing borrower companies.
Arun Nayyar, MD & CEO of NeoGrowth, emphasizes that the growth of the NBFC ecosystem will hinge upon robust risk management and governance mechanisms. "Through the amalgamation of technology, NBFCs embracing responsible lending practices and creating positive impacts will pave the way forward," affirms Nayyar.
