Regulatory tightening: Time to turn selective in the banking and financial services sector

17 Nov 2023 , 12:53 PM

Analysts at IIFL Capital Services estimate the CET1 impact to be higher for ICICI, RBL, IDFC FB and SBI (80-100 basis points) among the banks, and for Bajaj Finance and Poonawalla (~225 basis points) among the NBFCs. With the proforma CET1 ratio falling below the optimal threshold levels, additional capital hit from ECL provisioning norms from FY25 onwards (100-170 basis points of impact for PSU banks), and need for growth capital analysts at IIFL Capital Services expect banks like PNB, SBI, BOB, Federal, RBL and Axis to raise capital.

While high capital levels for the NBFCs (particularly post the recent raises) should provide them a cushion, analysts at IIFL Capital Services expect margin compression (increase in funding cost) and higher asset quality stress for some of them given the reliance on FinTech led originations. The second order impact of tighter regulations should manifest in form of growth slowdown for both banks and NBFCs, and increase in funding cost for the NBFCs. IIFL’s preferred picks are HDFC, IndusInd and Axis among banks, and Bajaj Finance among the NBFCs.

Higher risk weights to drive capital calls for select banks

The RBI has increased risk weights on PL and CC by 25% pts from 100%/125% to 125%/150% for banks and NBFCs. Risk weights have also been increased by 25% pts for bank lending to NBFCs/HFCs for ‘A and above’ rated NBFCs. Additionally, RBI now requires lenders to have a board approved caps for all unsecured consumer credit, and to classify top-up loans against vehicles as unsecured loans. Personal loans, credit card and NBFC exposure constitute 10-30% of total loans for banks and 5-35% for the NBFCs. Analysts at IIFL Capital Services estimate the CET1 impact to be higher for ICICI, RBL, IDFC FB and SBI (80-100 basis points) among the banks, and for Bajaj Finance and Poonawalla (~225 basis points) among the NBFCs. With the proforma CET1 ratio falling below the optimal threshold levels, additional capital hit from ECL provisioning norms from FY25 onwards (100-170 basis points of impact for PSU banks), and need for growth capital they expect banks like PNB, SBI, BOB, Federal, RBL and Axis to raise capital. High capital levels of the NBFCs (especially after the recent raises) should provide them a cushion, despite higher impact on the CET1 ratio.

Second order impact: Growth slowdown for banks/NBFCs and margin headwinds for NBFCs

Higher risk-weights and rising delinquencies should calibrate unsecured consumer loan growth. Lenders have already started scaling back in these segments and tightening underwriting for both ETC and NTC customers. Analysts at IIFL Capital Services expect COF to increase for the NBFCs, and increase reliance on market borrowings. With the banks’ looking to protect RoRWA on their NBFC exposure, they expect banks to increase lending rates by 50-60 basis points over next few quarters,resulting in NIM pressure for NBFCs. Reliance on bank funding is higher (50-60%) for mid-to-large NBFCs such as CIFC, LTFH, PEL, AB Fin but lower for BAF and SHFL (~25%). With NBFCs likely to incrementally tap market borrowings (bonds, CPs, etc.), it should also result in credit spreads widening for NBFCs.

AQ stress emanating in small-ticket PL and delinquencies rising in credit cards and MFI 

While the AQ stress in small ticket PL (STPL) is well known, we are also seeing signs of rising delinquencies in other unsecured loans such as credit cards and MFI. The 30/90 DPD on STPL (<Rs. 25k ATS) is 5-8x higher than larger ticket PL at 16.6%/10.4%. With Fintechs originating a majority of these STPL loans, their NPAs are 2-4x that for traditional lenders. Lenders such as AB Cap, SHFL, PEL, CIFC and IDFCB have 0.3-4.5% exposure to these STPL/Fintech loans. Credit card delinquencies have increased 10-100bps QoQ in Q2 FY24 (RBL, SBI cards). Whereas, MFI state level delinquencies have inched up by 10-90 basis points QoQ in MP/RJ/PB/UK/HR (14.6% of industry AUM) in Q1 FY24.

Consequently, MFIs reported 50-60 basis points QoQ increase in slippages (annualized) in Q2 FY24. Banks and NBFCs under our coverage have minimal exposure to STPL but MFI and credit cards constitute 1-35% of loans. With unsecured lending growth expected to slowdown, analysts at IIFL Capital Services expect delinquencies to further increase and are forecasting 10-40 basis points increase in credit costs over FY23 across banks and NBFCs under IIFL’s coverage.