NBFCs/FinTech’s Landscape – RBI’s lens

India’s NBFCs emerge as financial titans, allocate ₹7 lakh crore to retail – reads the caption of India Finance Report (2023) by RBI’s Centre for Advanced Financial Research and Learning (CAFRAL), last month.

In an epochal shift within India’s financial ecosystem, Non-Banking Financial Companies (NBFCs) have emerged as financial titans, making a monumental infusion of ₹10 lakh crore into the industrial sector. This significant move, highlighted in the latest report from the Reserve Bank of India’s CAFRAL marks a new era in growth financing.

The NBFC sector, an eclectic mix of 49 deposit-taking and 9,467 non-deposit-taking firms, with the non-deposit-taking systemically important NBFCs (NBFCs-ND-SI) accounting for over 85% of the total assets, has solidified its position as a key driver in India’s economic narrative.

This expansion in credit size is not just a quantitative leap but also a qualitative shift in the lending portfolio of NBFCs. Traditionally, the focus of these institutions was skewed towards the industry sector. However, the trends also show a growing emphasis on the retail loan segment, reaching nearly ₹7 lakh crores.

This strategic shift, particularly noticeable in the aftermath of the FY 2020 pandemic, is in line with the changing financial landscapes and consumer preferences across the nation. It is also reflective of the NBFCs’ agility in adapting to the evolving market dynamics and customer needs.

Furthermore, the NBFC credit’s contribution to India’s GDP has witnessed a remarkable rise. From holding 8.6% of the GDP in 2013, it escalated to 12.3% by 2022, signalling not only the sector’s growth but also its increasing influence in the retail finance market.

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Capital positions and asset performance.

In capital positions and asset performance, NBFCs in India have also demonstrated robustness and resilience. The sector has consistently maintained strong capitalisation with the capital to risk-weighted assets ratio (CRAR) often surpassing the regulatory threshold of 15%. In FY23, there was an improvement in CRAR, highlighting the sector’s financial health and stability. However, specific segments like NBFC-IDF (infrastructure debt fund) and NBFC-MFI (micro finance institutions) saw a decline in their CRAR, suggesting nuanced challenges within these sub-sectors.

Another significant aspect of the NBFC sector’s performance is the improvement in asset quality post-FY20. The gross non-performing assets (GNPA) ratio, a key indicator of asset quality, decreased from 6.0% to 5.8%, while the net non-performing assets (NNPA) ratio improved from 2.7% to 2.3% between FY21 and FY22. There has been a significant show of balance sheet strength in overall asset quality with NBFC’s successfully navigating through the economic challenges posed by the pandemic.

Turning to profitability, the NBFCs, especially the deposit-taking ones (NBFCs-D), have seen a marked improvement in their financial metrics in FY22 compared to FY21. The return on assets (RoA) and return on equity (RoE) for NBFCs-D have shown a positive trajectory, standing at 2.5% and 12.5%, respectively. Additionally, there has been an improvement in the NIM, which rose to 9.1%.

The non-deposit-taking NBFCs (NBFCs-ND) also mirrored this positive trend, with increases in RoA and RoE to 1.5% and 6.5%, respectively. However, their NIM has remained relatively unchanged. While the overall profitability of the sector is on the rise, certain operational efficiencies, particularly in the non-deposit-taking segment, continue to be areas for potential improvement.

Financial inclusion is robust.

A noteworthy development in the NBFC sector is the burgeoning growth in digital lending. While digital lending in banks is still in its nascent stage, with ₹1.12 lakh crore lent through digital channels compared to ₹53.08 lakh crore through physical modes, NBFCs are charting a different path. For NBFCs, a significantly higher proportion of lending is executed through digital means, with ₹0.23 lakh crore disbursed digitally, as opposed to ₹1.93 lakh crore through traditional physical channels.

This trend towards digital lending not only reflects the sector’s adaptability to technological advancements but also its commitment to meeting the evolving needs of a digitally savvy customer base. The shift towards digital channels also suggests a strategic reorientation within the NBFCs, positioning them at the forefront of leveraging technology to enhance financial inclusion and accessibility.

The role of NBFCs and FinTech-NBFCs in financial inclusion has been particularly pronounced in the area of retail credit growth. Between 2015 and 2018, NBFCs outperformed banks and housing finance companies (HFCs) in retail credit expansion. However, the period of 2018-2019 witnessed a slowdown in credit growth, largely attributed to stress factors such as the IL&FS incident. This trend reversed in 2021, with loan sanctions for NBFCs currently growing at an impressive rate of nearly 70% year-on-year, followed by HFCs at around 40%.

During FY17-21, the growth in the prime borrower segment for Scheduled Commercial Banks (SCBs) and HFCs was significantly outpaced by NBFCs and FinTech NBFCs, which catered not just to prime but also to subprime borrowers. In a striking development, FinTech NBFC lending to young borrowers increased by a hundredfold between 2015 and 2021. This contrasted with the trends in public sector and private banks, where growth was similar for both young and older borrowers, and HFCs, where the focus was more on older households.

RBI’s efforts in financial inclusion have led to 30% of bank branches being located in rural areas. This has facilitated retail lending growth more in rural areas compared to urban ones across lenders, as they began tapping into the underserved market segment. This differential growth was most pronounced for NBFCs (75%) and Fintech NBFC lenders (190%).

Household consumption expenditure in India has seen a significant rise, from ₹49 lakh crore in 2012 to ₹143 lakh crore in 2022. The personal final consumption expenditure (PFCE) maintained a compound annual growth rate (CAGR) of 5.4% between 2012 and 2022, increasing its share in GDP from 56.5% to around 60%. Analysis of credit and consumption data reveals a positive correlation between credit growth and consumption expenditure.

Interestingly, bank credit exhibits a stronger relationship with consumption growth compared to NBFC credit. However, NBFC credit supply shocks tend to elicit a stronger response in consumption. This suggests that declines in NBFC lending could have significant impacts on aggregate consumption. The responses are particularly marked in the education sector and are higher for rural than urban households. Middle-income and middle-aged households also show high consumption responses, with marginalized borrowers being more prone to adverse credit shocks. This highlights the critical role of NBFCs in sustaining consumption and economic growth, especially in underserved and vulnerable segments of the population.

Growing bank-NBFC interlinkages

The Indian financial landscape is witnessing an evolving synergy between banks and Non-Banking Financial Companies (NBFCs), significantly impacting monetary policy transmission. As of the first half of 2023, bank borrowings constituted nearly 36% of the total borrowings of NBFCs, underlining the growing interlinkages between these two sectors.

Public sector banks have emerged as the largest lenders to NBFCs, followed by private sector and foreign banks. This growing bank exposure to NBFCs, primarily through direct lending, has led to a notable correlation between the NBFC index and the bank NIFTY index. Such a trend not only signifies banks as a vital funding source for NBFCs but also reflects their interconnected roles in India’s financial system.

Over the past decade, systemic risk measures for the median NBFC, particularly those traded, have remained relatively subdued. This suggests that these entities were not yet considered systemically important. However, a different picture emerges when focusing on the five traded NBFCs classified as NBFC-UL (Upper Layer) by the Reserve Bank. NBFCs show a higher sensitivity to market shocks, indicating a gradual increase in systemic risk. This trend underscores the deepening integration of NBFCs with the broader financial system and their growing significance in India’s economic fabric.

Monetary policy transmission evident

In emerging markets like India, the credit channel, primarily driven by banks, plays a crucial role in monetary policy transmission. Changes in monetary policy directly influence bank credit flows by affecting banks’ funding costs and the valuation of collateral. The impact on market rates is immediate, especially at the short end for government and corporate bonds, thereby influencing firm investments and the overall yield curve.

Despite the growing influence of NBFCs, banking sector assets were over 6.5 times the size of NBFC assets as of March 2022. This vast difference highlights the dominant role banks still play in India’s monetary policy transmission, even as NBFCs continue to carve out a significant niche in the financial ecosystem.

Key takeaways

  1. Fintech can emerge as substitute for traditional banking.
  2. Indian fintech sector is growing rapidly and has the potential to reach a market size of $1 trillion by 2025.
  3. Fintech companies are offering a wide range of innovative products and services that are disrupting the traditional banking industry.

The way forward

As the Indian financial landscape continues to evolve, the role of Non-Banking Financial Companies (NBFCs) becomes increasingly prominent, not only in terms of their growing interlinkages with the banking sector but also in their impact on the broader economy. The synergy between banks and NBFCs has become a crucial aspect of monetary policy transmission, reflecting a maturing financial ecosystem that is more interconnected and dynamic.

Despite the prevailing dominance of banks in the economic framework, NBFCs have carved out a significant role for themselves, evidenced by their robust participation in growth financing and financial inclusion, particularly in underserved regions and sectors. Looking ahead, with their expanding portfolio, improved asset quality, and adaptability to digital trends, NBFCs are poised to play an even more influential role in India’s economic narrative. In India’s GDP g, the influence of NBFCs is expected to grow stronger, cementing their position as indispensable pillars of the nation’s financial infrastructure.

Centre for Advanced Financial Research and Learning (CAFRAL), a not-for-profit organisation, was set up in 2011 as an independent body by #RBI to promote research and learning in banking and finance.

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