Here is what the December 2023 RBI FSR says about Indian NBFCs

2 Jan 2024 , 11:58 AM

What does the RBI’s FSR say about health of NBFCs?

The latest RBI Financial Stability Report (FSR) for the half year of FY24, ending September 2023 has also outlined the story of NBFCs, especially the systemically important NBFCs in India. The Indian NBFC segment has been fairly diverse. There are the government owned power finance companies like REC, PFC and IREDA at one end. Then there are the large private sector lenders like Bajaj Finance and HDFC Ltd (now merged into HDFC Bank). Then there are scores of other financial companies like AMCs, MFIs, smaller housing finance companies etc. The RBI FSR gives a generic view on all these categories of NBFCs in India. 

Let us first look at how NBFCs in India performed at a macro level in the September 2023 half. The NBFC aggregate lending in the September 2023 half grew by 20.8%; almost double the rate of growth of just 10.8% recorded in the previous year corresponding period. However, it emerges that the growth of NBFC credit has been largely driven by personal loans. For instance, NBFC personal loans have grown at a rate of 33% CAGR for the last 4 years. Within NBFCs, the state sponsored NBFCs account for 43% of the total credit and this credit is largely for industrial purposes. The 33% CAGR growth in personal loans is sharply higher than their 15% CAGR growth in overall loans over the same 4 year period.

Charting loan growth of NBFCs for H1FY24

As stated earlier, the loan growth for NBFCs overall stood at 20.8%. But what were the components that drove the loan book sharply higher? Massive growth of 43.7% was in the agricultural loan books. For NBFCs overall, the personal consumption loan book constitutes about 31.8% of the overall NBFC book. The personal finance loans by NBFCs grew by a hefty 32.5% in H1FY24. 

Among other segments catered to by the NBFCs, the total lending to the services sector grew by 17.3% while the lending to industry grew by 16.1%. What is interesting is that all the 4 key components of the NBFC lending basket viz., agricultural loans, personal loans, service sector loans and industrial loans showed sharp improvement in growth in H1FY24 compared to the sequential half. The growth in industrial advances was largely driven by the PSU NBFCs lending towards power and railway infrastructure.

For NBFCs overall, the industrial lending book constitutes the largest chunk of 36.1% of the overall NBFC book. This is largely dominated by the government sponsored financial institutions. The second largest component of the NBFC lending book is personal loans, which accounts for 31.8% of the overall NBFC book, while services constitute 14.6% of the overall NBFC lending book. Credit growth by the NBFC sector in the post-pandemic period has accelerated for investment and credit companies (NBFC-ICCs), moving to double digits for infrastructure finance companies (NBFCIFCs), and exceeding 30 per cent for micro-finance institutions (NBFC-MFI).

How does the asset quality of NBFCs look like in H1FY24

Asset quality of NBFCs continued the trend of improving sharply in H1FY24 also. This trend has been consistently visible in the last 4 sequential halves. The overall gross NPAs of the NBFC sector falling from 5% in March 2023 to about 4.6% in September 2023. The gross NPAs have fallen across all category of loans. In terms of absolute gross NPAs as percentage of loans, the services sector has the highest gross NPA ratio of 8.1% followed by industrials at 5.7% and agriculture at 5.3%.

The personal consumption loans have the lowest gross NPAs at 3.6%. If you look at the gross NPAs of NBFCs from a slightly longer term perspective; between September 2021 and September 2023, the gross NPAs have fallen from 7.2% to 4.6%. During the same period, the net NPAs have also fallen from 3.2% to 1.5%, showing substantial part of the gross NPAs provided for. However, the latest RBI directive to make personal loans more expensive is intended to prevent any potential crisis on the personal lending front for NBFCs.

How did NBFCs measure up on profitability in H1FY24

Even as the gross and net NPA levels of the NBFCs tapered, there was also a gradual improvement in the profitability of the NBFCs in H1FY24. The cost to income (C/I) ratio has been steadily falling in the last 3 sequential periods and it is now down from 52% to 43% in the last one year. During the same period, the net interest margins (NIMs) have gradually moved up from 4.5% to 5.1%. This is also called the spread margins in the lending business.

It must be remembered here that while NBFCs earn higher yields on their loans given compared to the banks, but they do not have the benefit of low cost CASA deposits which banks enjoy. Despite that, they have managed to maintain the NIMs at sharply higher levels. The return on assets (ROA), a critical measure for financial companies, has remained stable between 2.7% and 2.9%, albeit with a strong upward bias. The ROA and the NIMs of NBFCs have been relatively higher than that of banks at a macro level, due to smaller asset base.

Capital adequacy position of NBFCs as of H1FY24

During the March 2023 quarter, the NBFCs maintained high capital adequacy ratio on the back of robust profits and requisite capital raising done by the NBFCs. Over the last one year, the capital adequacy has been stable around 27.6%, which is well above the statutory minimum requirement of 15%. That leaves the NBFCs with a lot of room to grow their asset books from the current levels. While capital adequacy is one way of looking at the quality of the balance sheet, there are other measures too. 

For instance, for the NBFCs as a whole, the short term liabilities as a share of total assets stands at 24.3% while the long term assets as a percentage of total assets stands at a healthy 65.2% in H1FY24. These ratios have been stable over the last 3 sequential periods, with a favourable bias. According to the RBI FSR, 88% of the bonds issued by NBFCs had residual maturity of up to 5 years in September 2018 which fell sharply to 76% in September 2023. This shows that there is elongation in tenor of bonds. 

Balance sheet structure of NBFCs as of the end of H1FY24

There has also been a shift away from short-term borrowing for these NBFCs as the share of short-term borrowings in total borrowings came down from 47.7% in September 2018 to 37.3% in September 2023. Apart from their increasing preference for longer term sources of funds, there has also been a shift towards long-term uses of funds. On the asset side, about 80% of loans and advances for major NBFCs had a maturity of less than 3 years in September 2018, which reduced to 67% in September 2023. Most of the longer term loans given by NBFCs are essentially the term loans given by the power finance institutions to its power sector clients. That is why, it is the government sponsored power finance and railway finance companies that oversee bulk of the longer term loans given out by the NBFCs.

Between March 2021 and September 2023, the share of borrowings in the balance sheet has fallen from 63.0% to 62.1% while the share of equities has risen from 26.7% to 27.9%. Within the borrowing basket, the share of bank borrowings has gone up from 19.8% in March 2021 to 27.9% in September 2023. How does the mix of bonds mobilized by NBFCs look like. Only 5.4% of the bonds issues by these NBFCs are below investment with 94.6% being investment grade. Out of the investment grade bonds issues by NBFCs, AAA rated bonds are 59.8%, while AA rated bonds are 25.5%.  Even the stress tests on capital and liquidity show that NBFCs are well positioned to handle any shocks in the next one year, irrespective of intensity. The impact on the capital adequacy and the gross NPAs even in an extreme stress condition is unlikely to be anything to worry about.

What the FSR says about Insurance sector and Mutual Funds

While the insurers and mutual funds are not strictly lending NBFCs, they do form an important part of the financial system in terms of their AUM and the risk metrics as well as in their strong retail reach. Let us focus on insurance first. In terms of solvency ratio for life insurance companies, LIC has consistently held the solvency ratio in the range of 185% to 190% while private life insurers overall have maintained solvency ratio above 220%. The threshold prescribed by IRDA is 150%, so both are above the mark, although the position is a lot more comfortable in the case of the private life insurance companies. For the industry as a whole, the average solvency ratio is stable at around 197. However, in the case of the non-life insurance companies, the situation is slightly different. Here, private non-life insurers have comfortable solvency ratio of above 220% while it is sub-optimal (under 100) for the PSU general insurance companies in India.

What does the FSR say about mutual funds in India? In terms of the 42 AMCs that underwent stress test, 25 AMCs showed no signs of stress while 17 AMCs showed some signs of stress. The stressed NBFCs are higher than 14 in March 2023. Stress test normally refers to the debt fund schemes. In terms of schemes, 275 out of 299 schemes reported no stress while the 24 companies that reported stress accounted for over 10% of the debt fund AUM. That remains a concern for the mutual funds on the debt funds side.

Overall, the risk and stress situation appear to be under control as far as the NBFCs are concerned. However, PSU general insurance companies have exhibited some stress in terms of solvency while debt funds are still reporting fairly high levels of stress in select categories.