Large NBFCs coming out of the shadows to become multi-product, diversified lender: IIFL Capital Services

NBFCs have become a prominent player in the Indian Credit landscape, representing 25%/21% of total / retail + SME credit (excl. HDFC Ltd). Categorised as Upper Layer by RBI, large NBFCs are now subject to bank-like regulations for capital, liquidity, governance and operational requirements. At the same time, credit bureaus have also evolved to provide rich data sets with predictive models, enabling lenders to build multi-dimensional underwriting models. On back of these, large NBFCs are pivoting from being mono-line / niche lenders to become multiproduct, diversified lenders. These new segments are large ($200-450bn market size), presenting secular growth runway. 

Consequently, analysts of IIFL Capital Services expect large NBFCs to grow faster even at scale: 

26% FY23-26 Cagr compared to 16% last 10Y Cagr. NBFCs have evolved unique strategies to scale up new segments that leverage their existing strengths – physical distribution network, customer segment, geographical knowledge. Incrementally, new segments would have 70/130bps lower yields for BAF / MMFS. For SHFL, SCUF’s consumer loans are margin accretive (400bps) and for LTFH new segment yields are similar to current book yields. Analysts of IIFL Capital Services also highlight runaway growth in Personal loans (27% 4yr Cagr and 36% YoY in FY23) as an area of concern. Analysts of IIFL Capital Services find rising vintage delinquencies for unsecured loans, rising small-ticket PL delinquencies that are 2x of big-ticket PLs and the falling approval rates by lenders — as signs of stress brewing up in the segment. Analysts of IIFL Capital Services expect the FinTech players and lenders who rely on them for sourcing (aka Piramal, AB Finance, etc.) to be mainly impacted. HDFCB, ICICI, SBI and BAF have only low-single digit 30+ DPD in unsecured loans, as their primary focus is on lower-risk ETB borrowers (60-85% share in PL).

Shadow banks no longer operating in the shadows

NBFCs, or shadow banks as they are referred to globally, have become prominent players in the Indian Credit landscape, representing 25% of total bank + NBFC, 21% of retail + SME credit (incl. HFC, but excluding HDFC Ltd that has merged into HDFC bank). In FY19, their credit market share peaked at 27%, thereafter declining to 25% as the access to wholesale funding dried up post the IL&FS and DHFL crisis. This led to NBFCs relying more on banks – share of bank borrowings for NBFCs has increased to 38% from 24% in FY17 (including HDFC, share changes to 23% in FY17 and 36% in FY22).

Credit crunch in the aftermath of IL&FS and DHFL crisis underscored the significance of NBFCs in credit delivery, as also their interconnectedness with banks and the broader financial system. This prompted RBI to revamp regulations for NBFCs with the objective to strengthen supervision and regulations for large NBFCs — manifesting in the form of RBI taking over as the regulator for HFCs (from National Housing Bank) and introducing bank-like regulations for NBFCs and HFCs: 1) Stringent liquidity requirements (tightened ALM requirements with explicit focus on shorter maturity buckets and introduction of LCR for NBFCs). 2) Scale-based regulations for NBFCs with requirements such as appointment of independent CCO, formation of Board-level committee on risk management, mandatory core banking solutions, introduction of leverage cap, large exposure framework, sensitive sector exposure framework, internal exposure limits for the upper layer NBFCs. With applicability of such bank-like regulations, upper layer NBFCs are regulated and supervised like banks by RBI.