After weathering multiple challenges over the past three fiscals, assets under management (AUM) of non-banking financial companies (NBFCs)¹ is set to grow 8-10% next fiscal, riding on two tailwinds — improving economic activity, and strengthened balance sheet buffers. That compares with an estimated growth of 6-8% this fiscal and 2% last fiscal (see annexure 1).

To be sure, they are also facing three headwinds: first is intensifying competition from banks that, flush with liquidity, have sharpened focus on retail loans. Second, gross non-performing assets (GNPAs) are expected to increase, mostly because of the revision in recognition norms and, to some extent, due to slippages from the restructured book. And third, funding access is yet to fully normalise for some of the players (see annexure 2).

Says Gurpreet Chhatwal, Managing Director, Crisil Ratings Ltd, “Many NBFCs have built higher liquidity, capital and provisioning buffers in the recent past. That, combined with improving economic activity, puts them in a comfortable position to capitalise on growth opportunities. However, competition from banks will intensify. Asset quality worries have also manifested due to recent regulatory clarifications, and uncertainty over the performance of the restructured book. Net-net, growth will be driven by NBFCs with strong parentage² and better funding access in the two largest segments — home loans and vehicle finance.”

Organic consolidation is also underway with larger NBFCs gaining share. In three fiscals through 2021, the market share of the top 5 NBFCs has risen 600 basis points (bps) to 46%. The ability to identify niches that cater to the relatively difficult-to-address customer segments and asset classes will fuel long-term growth for the sector.

Retail loans are expected to see reasonably broad-based growth in the current and next fiscals supported by pick-up in demand and consequently underlying sales. Gold, home and unsecured loans should clock the fastest growth rates. On the other hand, wholesale credit would continue to degrow as platforms such as alternate investment funds gain currency.

In terms of asset quality, the change in the Reserve Bank of India’s (RBI) NPA recognition norm to a daily due-date basis instead of the month-end will have implications. Typically, NBFCs ramp up collection activity between the due date and the month-end, which is why their overdues reduce by the end of the month. However, this flexibility is no longer available. And bounce rates in the 60-90 days bucket are estimated at 25-35%. Consequently, a significant proportion of loans in the 60-90 days bucket may slip into the >90 days overdue bucket and will have to be recognised as NPAs.

Crisil Ratings expects GNPAs to increase by 25-300 bps based on asset class because of the new recognition norm. While home loans and gold loans will be the least impacted, unsecured, and micro, small and medium enterprises loans will bear the brunt.

However, the increase in GNPAs because of the revised recognition norms will be largely an accounting impact because, given the improving economy, the credit profiles of borrowers are not expected to deteriorate. Consequently, ultimate credit losses are not expected to change significantly.

Another monitorable is the performance of the restructured book. While there has been across-the-segment improvement in the monthly collection efficiency ratio³ (MCR) of NBFCs for the quarter ended September 2021, the quantum of restructuring done under the RBI Resolution Framework 2.0 is more than last year. Since this mostly involved offering moratorium, the performance of this book after moratorium is monitorable.

Overall, fragile assets (GNPAs + slippages due to the impact of regulatory norms and from the restructured book) are seen at Rs 1.3-1.6 lakh crore, tantamount to 5-6% of the industry’s AUM as of March 2022. This does not factor in the impact of a third wave of Covid-19, especially the just-discovered Omicron variant, which is a risk factor.

Says Krishnan Sitaraman, Senior Director and Deputy Chief Ratings Officer, Crisil Ratings Ltd, “While there may be apprehensions about rising reported GNPAs, additional disclosures by NBFCs around underlying delinquency profiles and collection efficiencies can help allay them. Those with low leverage, high liquidity and strong parentage are expected to benefit from better funding access at optimal rates. For the rest and especially mid-sized and smaller players, co-lending, securitisation, or other partnerships with banks will facilitate a funding-light business model.”

1 Comprising both non-banking finance companies and housing finance companies
2 Non-banks that are backed by strong corporate groups / parents or having a bank in the group.
3 Monthly collection efficiency = Total collections (excluding foreclosures)/scheduled billing (unadjusted for moratorium)