About two months back, the Reserve Bank of India (RBI) decided to limit the banking sector’s ballooning exposure to non-banking financial companies, or NBFCs. The banking regulator had concerns about the banks’ exposure to the NBFCs, which had grown by 400% within 5 years, from ₹3.5 trillion to ₹13.5 trillion. This value does not include banks’ investment in NBFC securitisation transactions, non-convertible debentures (NCDs), commercial papers, co-lending arrangements, etc. Moreover, many banks reached their sectoral limits of lending to NBFCs.
The regulator viewed this trend as a systematic risk and increased the risk weight of unsecured lending by banks to NBFCs from 100% to 125%. The risk weight of lending to housing finance and priority sectors by NBFCs remained unchanged. Post this change, banks must keep extra money aside every time they lend to NBFCs. Since banks now have less opportunity to lend to NBFCs, they have increased the interest rate on loans given to NBFCs to maintain a significant revenue stream. Some banks have also reduced their lending to the NBFCs. On the other hand, NBFCs face increased costs of growth capital and reduced liquidity. As a result, the NBFC sector’s assets under management growth is expected to slow down to 14-17% in FY25, compared to the projected 16-18% for FY24, as per an estimate by Crisil Ratings.
Drying growth capital for NBFCs
Over the last few years, other funding sources for NBFCs have also shrunk. For instance, after the Franklin Templeton crisis, mutual funds are not keen to underwrite credit risk and have deliberately reduced their credit exposure to NBFCs by more than 60%. Other popular ways for NBFCs to raise capital were market-linked debentures (MLDs) subscribed by high-net-worth individuals (HNIs) and NCDs subscribed by foreign investors.
Between January 2018 and 2023, as many as 150 issuers had cumulatively raised ₹83,000 crore through MLDs, with an increasing annual trend. The key reason was that until the union budget 2023, the returns on MLDs held for more than one year were classified as long-term capital gains and taxed at 10%. Hence, HNIs could invest in a fixed-income instrument for comparatively lower taxes. However, since 1 April 2023, the gains from the sale of MLDs are treated as short-term capital gains and taxed at the investor’s applicable tax slab. Thus, HNIs have no tax advantage of investing in MLDs, and the MLD issuance has reached almost zero in FY 24.
Akin to MLDs, foreign investors enjoyed a concessional tax rate of 5% on their earnings from interest on NCDs issued by Indian entities. Since June 2023, this tax has also shot up to 20%, making NCDs less attractive for foreign investors.
Corporate bonds to the rescue
NBFCs must borrow from alternative sources to meet their capital needs at optimal cost. In the financial world, one’s loss is often another’s gain. Thus, in the coming days, we will see more NBFCs issue corporate bonds that can be subscribed to by mutual funds, insurance companies, and retail investors. The capital appetite will also lead to an increase in bond yields in the mid-term. According to industry estimates, the yields could increase by 25-100 basis points based on the credit rating and sector. The higher yields and increased choices will encourage more retail investors to explore corporate bonds and provide depth to the Indian bond market.
Crisil Ratings projects corporate bond issuances in India to grow more than double and touch ₹100 trillion from the current outstanding of about ₹43 trillion. Market regulator Sebi has already floated a consultation paper proposing a reduction in the face value of privately listed bonds to ₹10,000 from ₹1 lakh. Once the recommendation is implemented, retail investors are expected to pick up a significant chunk of the growing pool of corporate bonds.
We have already seen how regulatory ease and awareness have changed the way retail investors participate in equity markets and even counterbalance foreign investors to some extent. As NBFCs diversify their borrowings, we can expect a similar trend in the debt market. At the same time, the NBFC ecosystem will be better capitalized to take on any unwanted storms.
Anshul Gupta is co-founder and chief investment officer, Wint Wealth.
Here’s your comprehensive 3-minute summary of all the things Finance Minister Nirmala Sitharaman said in her Budget speech: Click to download!
Download The Mint News App to get Daily Market Updates.
Published: 12 Feb 2024, 09:16 PM IST