Non-banking financial companies (NBFCs) have started realigning portfolio strategies for better risk-adjusted returns, with a focus on unsecured loans and MSME finance, anticipating an increase in cost of funds amid rising interest rates and reduced competitiveness in traditional segments – home and new vehicle loans – due to intensifying competition from banks.

In the last few years, NBFCs have navigated multiple challenges, exacerbated by the Covid pandemic, and emerged with enhanced resilience. Now, stronger balance sheets with higher provisioning and lower leverage, receding asset-quality concerns and steadily normalising funding access, provide NBFCs a strong foundation to boost growth, as credit demand piggybacks the ongoing economic rebound.

Overall, NBFCs are expected to grow their assets under management (AUM) by 13-14 per cent next fiscal, or twice the 7 per cent pace logged last fiscal. The portfolio realignment is visible already. In the first half of this fiscal, the share of disbursements in unsecured loans to total retail disbursements (excluding gold loans) increased to 35 per cent from 30 per cent last fiscal and 25 per cent in the previous fiscal.

Disbursement of unsecured loans had doubled on-year last fiscal, and rose almost 50 per cent in the first half of this fiscal on an annualised basis. For the whole of this fiscal, unsecured loans are seen growing 20-25 per cent — higher than in the past two fiscals — to near the pre-pandemic level.

Disbursements in MSME finance have also increased substantially, surging 55 per cent on-year last fiscal and maintaining momentum in the first half of this fiscal, following a slowdown in the last 3-4 years. In fact, disbursements had declined on-year in fiscal 2021.

In short, therefore, AUM in these segments will drive growth for NBFCs, going forward. As large NBFCs turn towards non-traditional segments to enhance yields, we may also see more partnerships, such as co-lending with emerging NBFCs focussing on specific asset classes, especially unsecured loans. This allows the large NBFCs to expand to newer domains in a more cost-efficient manner while reducing time-to-market; for emerging ones, it supports capital-efficient AUM growth.

This doesn’t imply the traditional segments will not grow. In home loans, which is the biggest segment, making up 40 per cent of the NBFC AUM, structural factors driving end-user housing demand are intact despite the impact of rising real estate prices and interest rates. That should drive 13-15 per cent growth in the segment next fiscal.

That said, banks are quite competitive in home loans and housing finance companies (HFCs) could keep losing market share to banks amid intense competition on interest rates, especially in the urban and the formal salaried segments. As such, banking sector growth is expected to be buoyant, going forward, with the share of retail in the advances expected to rise.

Rising rates will also lift the borrowing cost of NBFCs and lower their competitiveness versus banks, which have access to lower-cost funds. NBFCs are expected to maintain their hold in the self-employed professionals and affordable housing segments, though. Vehicle finance, the second-largest segment (20-25 per cent of NBFC AUM), will grow 12-14 per cent over the next two fiscals, on the back of solid underlying-asset sales.

Strong pent-up demand and new launches will continue to drive car and utility vehicle sales. The ongoing rebound in economic activity, demand for fleet replacement, and focus on last-mile connectivity will support commercial vehicle sales.

In the new-vehicle finance segment, especially cars, interest-rate sensitivity of borrowers is high, so competition from banks remains tough given their ability to offer finer pricing. Consequently, NBFCs will likely capitalise on their core strengths of last-mile connectivity, customer relationships, and innovativeness and strong understanding of micro markets to sharpen focus on used-vehicle financing, which offers higher yields and better profitability from a risk-adjusted returns perspective.

AIF route

While all segments will witness a strong rebound, real estate finance may continue to be catered via the Alternate Investment Fund route. Some NBFCs may look at a calibrated re-alignment of exposure to construction finance for large developers, lease rental discounting loans, and last-mile financing as these carry relatively lesser risk and potential for higher returns.

To sum up, NBFCs are well placed today to capitalise on the opportunities ahead. The nimbleness of the sector should allow for a quick recalibration of portfolio strategies and ensure sustained growth, though higher-than-expected inflation and interest rates remain key monitorables.

Krishnan Sitaraman is Senior Director and Deputy Chief Ratings Officer of CRISIL Ratings Limited

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