How Retail Investors Can Leverage Opportunities NBFCs Offer

The growth in the Assets Under Management (AUM) of the Non-Banking Financial Company (NBFC) sector is projected to decelerate to around 14-17% by FY25, according to predictions. However, despite this anticipated slowdown, NBFCs still present ample opportunities for retail investors.

The Reserve Bank of India’s Action on NBFCs

Recently (approximately two months ago), the Reserve Bank of India determined it was pivotal to check the banking sector’s excessive exposure to NBFCs. Concerns heighten over the banking sector’s vulnerability to NBFCs, considering the exposure had magnified by 400% in the span of five years, escalating from ₹3.5 trillion to a whopping ₹13.5 trillion. These figures don’t incorporate the banks’ investment in areas such as NBFC securitisation transactions and non-convertible debentures (NCDs).

In response to this skyrocketing trend, the regulator made strategic modifications to safeguard the sector by increasing the risk weight of unsecured lending by banks to NBFCs from 100% to 125%. Consequently, banks are now obligated to reserve extra funds for each loan they attribute to NBFCs. As a result, banks are increasing the interest rates on loans provided to sustain their revenue stream and decrease their lending practices towards NBFCs.

The Capital Crunch in NBFCs

Additionally, we’ve observed that funding sources for NBFCs have deteriorated over the last few years. Particularly after the Franklin Templeton crisis, mutual funds have become inclined to minimize their credit risk, reducing their credit exposure to NBFCs by more than 60%. NBFCs were previously able to raise capital through market-linked debentures (MLDs) subscribed by wealthy individuals (HNIs) and NCDs subscribed by foreign investors. This, however, is no longer able to continue.

Between January 2018 and 2023, a cumulative total of ₹83,000 crore was raised by 150 issuers through MLDs. The primary motivation for this was the classification of returns on held MLDs for over a year as long-term capital gains, taxed at 10%. However, policies changed on 1 April 2023, and the gains from the sale of MLDs were treated as short-term capital gains and taxed according to the investor’s respective tax slab. In a similar vein, NCDs also lost their appeal to foreign investors as tax rates surged from 5% to 20%.

Corporate Bonds: A Potential Lifeline for NBFCs

In this precarious financial climate, NBFCs are urged to source from alternative options to fulfill their capital requirements at a reasonable cost. As a matter of course, the financial world operates on a principle where loss for one often spells a gain for another. Consequently, in the days to come, it is likely that there will be a rise in NBFC-issued corporate bonds that can be availed by mutual funds, insurance firms, and retail investors. The ensuing demand for capital is predicted to escalate bond yields in the mid-term, causing a surge in the range of 25-100 basis points depending on the credit rating and sector.

The Anticipated Growth of The Corporate Bond Market

With the introduction of more corporate bonds in the market, retail investors are now offered a broader array of options, hence making them attractive investment opportunities. This stimulates interest in retail investors to explore corporate bonds in depth, contributing to the expansion of the Indian bond market.

Crisil Ratings speculates that corporate bonds’ issuance in India is set to grow exponentially, reaching a staggering sum of ₹100 trillion from the current outstanding amount of around ₹43 trillion. The market regulator, the Securities and Exchange Board of India (SEBI), has proposed the reduction of the face value of privately listed bonds from ₹1 lakh to ₹10,000 which will further stimulate retail investment in corporate bonds.

Already, we have witnessed drastic changes in retail investment patterns thanks to regulatory accommodation and increased awareness. Similarly, as NBFCs broaden their borrowing practices, we can anticipate analogous transformations within the debt market. In tandem with these changes, the NBFC ecosystem will simultaneously accumulate enough capital to combat any undesirable financial turbulence, proving that even with a slowdown, “NBFCs are an opportunity for retail investors.”