The Future of NBFC's: Diversifying Funding Beyond Traditional Banking

SYNOPSIS

NBFC's are shifting beyond traditional bank funding to mitigate risks and enhance financial stability. With RBI’s push for diversification, they are tapping into debt markets, international funding, and securitization. This strategic shift aims to ensure long-term sustainability, reduce borrowing costs, and strengthen resilience in India’s evolving financial landscape.

Exploring Innovative Funding Avenues for NBFC's: A Creative Shift Beyond Traditional Banking Methods.

NBFC's received a recommendation & guidelines from RBI to diversify sources of funds as NBFC's have highly relied on Traditional banks as a critical risk mitigation strategy this also exposes them to systemic vulnerabilities. Other than this, Banks also funds directly into debentures and commercial papers issued by NBFC's, highlighted in RBI Trend and Progress reports. The exposure of banks as a share of NBF'C decreased slightly from 43.7% to 42.7% stated RBI which Supports Financial Stability. During the pandemic and post-Infrastructure Leasing & Financial Services crises, reliance on banks increased and NBFC faced liquidity challenges. RBI increased the risk weight for bank funding NBFC's from 100% to 125% in November 2023. This move is expected to make loans more expensive as NBFC's pass on the additional cost of bank borrowing to their customers.

NBFC's are exploring alternatives to source funds through various instruments:

NBFC's with better ratings have explored the debt markets to raise funds through commercial papers and bonds. Some of the NBFC's have tried internationally to raise a considerable amount in the abroad market. Some are utilizing the security market to do the same.

Increased use of Non-Convertible Debentures:

Funds deployed by NBFC's using the issuance of non-convertible debentures NCD's has increased in 2023-2024 with more than 80% of issuance being highly rated as AAA to AA, which are borrowed by NBFC's via Commercial Papers that too increased in the same period stated in the report.

RBI's advice to NBFC's:

As NBFC's have a ‘growth at any cost’ approach RBI has warned NBFC's saying it would be counterproductive, and suggested implementing a strong framework for Risk Management. RBI has also mentioned that NBFC's should be cautious while evolving concentration risk and climate changes affect financial risk linked with credit to certain sectors in the future to alert of cybersecurity threats. While Return on Asset (RoA) and Return on Equity (RoE) have improved during the year 2023-24 the middle layer’s credit growth was unchanged on account of contraction in unsecured loans. 

NBFC's Expand Through Diversification & Co-Lending:

NBFC's are expanding their product portfolio, diversifying their lender base and strengthening co-lending arrangements with banks. For example, U-GRO Capital has diversified its liability across banks, large NBFC's, capital markets, and financial institutions.

Conclusion:

The core strategy for funding NBFC's has to push for diversification. Apart from reliance on traditional banks for funding NBFC's will improve financial stability, and operational flexibility also mitigates systemic risks. This will also lower the rate of interest for both NBFC's as well as for public. Diversification will be the key to ensuring long-term sustainability and relevance in India’s dynamic economic framework.

Thankyou.

Regards,

Darshana Chauhan

Kautilya, IBS Mumbai.