Executive summary

After weathering multiple challenges over the past three fiscals, made worse by the Covid-19 pandemic, nonbanking financial companies (NBFCs)¹ in the private sector are expected to see their assets under management (AUM) grow 8-10% next fiscal, compared with an estimated 6-8% in the current fiscal and 2% in the last. The upturn will ride on two tailwinds - improving economic activity and strengthened balance sheet buffers.

NBFCs have navigated the challenges in the past couple of years by focusing on higher liquidity, capital and provisioning buffers. These, combined with improving economic activity, have put the sector in a comfortable position to capitalise on growth opportunities.

That said, NBFCs are facing three headwinds. First, intensifying competition from banks that, flush with liquidity, have sharpened focus on retail loans, which are the mainstay of NBFCs. Second, gross non-performing assets (GNPAs) are expected to increase, mostly because of the recent regulatory clarification 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.

Net-net, growth will be driven by NBFCs with strong parentage 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 the three fiscals through 2021, the market share of the top 5 NBFCs has risen 600 basis points (bps; 100bps = 1%) 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.

Asset quality performance will drive the sector's fortunes going forward.

The recent regulatory clarification in NPA recognition norm to a daily due date basis instead of the month-end will have implications as NBFCs ramp up collection activity between the due date and the month-end - the reason their overdue reducesby the end of the month. However, this flexibility is no longer available.

Also, 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.

However, the increase in GNPAs because of the regulatory clarification in 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.

What also bears watching is the performance of the restructured book. While the monthly collection efficiency ratio² of NBFCs has seen an improvement across segments in the quarter ended September, the quantum of restructuring done under the RBI Resolution Framework 2.0 is more than that logged last year. The performance of this book after moratorium is monitorable as it mostly involved offering moratorium.

In the milieu, additional disclosures by NBFCs around underlying delinquency profiles and collection efficiencies can help allay any apprehensions around rising reported GNPAs. Players with low leverage, high liquidity and strong parentage are expected to benefit from better funding access at optimal rates. For the rest - 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 in private sector; excludes government-owned entities
² Monthly collection efficiency = Total collections (excluding foreclosures)/ scheduled billing (unadjusted for moratorium)