Funding costs for non-bank finance companies (NBFCs) in India are rising, but strong credit demand fuelled by the country's robust economic growth will support the sector's profitability, according to Moody’s Ratings.

“We expect loans at NBFCs to grow about 15% in the next 12-18 months, driven by various types of lending, including infrastructure financing by large government-owned NBFCs and loans to small and medium-sized enterprises,” the rating agency says in a report.

Growth in unsecured retail loans will slow after the Reserve Bank of India (RBI) raised the risk weight of such credit assets for both banks and NBFCs by 25 percentage points in December 2023, says Moody’s.

“We expect India's economy to expand 6.6% in the year ended March 2025 (fiscal 2025) and 6.2% the following year, and this will lead to robust loan growth at NBFCs, mitigating the impact of rising funding costs on their profitability,” the rating agency says.

Aggregate year-on-year loan growth at NBFCs accelerated to 20.8% in September 2023 from 10.8% a year earlier, driven by demand for retail loans, including financing for housing and automobiles.

NBFCs’ profitability will moderate somewhat in the next 12-18 months as funding costs for them will increase, says Moody’s. "We also expect the sector’s credit costs to increase from cyclically low levels, especially as unsecured loans mature," it says.

Borrowing from banks, a key funding source for NBFCs, has become costlier for the sector since the RBI raised the risk weight of banks’ exposures to the sector for the calculation of their regulatory capital.

The measure has led banks to raise rates for loans to NBFCs to compensate for greater capital charges. Funding costs for large NBFCs increased about 50 basis points on average in fiscal 2024 from the prior year.

"The cost of borrowing from banks will increase further in the next 12 to 18 months. Banks are still repricing their loans to NBFCs at higher rates to reflect rate hikes by the RBI in 2022-23. In addition, banks will pass higher deposit costs onto borrowers including NBFCs after raising deposit rates to attract more deposits as credit demand outstrips deposit growth," says Moody's.

"Further, we expect some NBFCs to reduce unsecured lending and increase secured lending after the central bank raised the risk weight for unsecured retail loans. While the shift is positive for NBFCs' asset quality, it will weigh on their NIMs as yields on secured loans tend to be lower," it says.

Yet many NBFCs have passed increases in funding costs onto their customers, and this will help mitigate pressure on their margins, as per Moody's.

"Also, the largest NBFCs have access to diverse funding sources including retail deposits and external commercial borrowing. Their NIMs will hold up better as they have greater funding flexibility," the ratings firm says.

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