Whalesbook
Funding Costs Rising, Sector Restructures
Indian non-banking financial companies are facing rising funding costs, as noted by India Ratings. This increase, though slight, is driven by a mix of global geopolitical tensions and domestic economic uncertainty, which are widening bond market spreads and making debt more expensive. Banks' own challenges, including increased competition for deposits and high loan-to-deposit ratios, also limit their ability to pass on policy rate cuts. As a result, borrowing costs for NBFCs and Housing Finance Companies (HFCs) are unlikely to decrease significantly soon. The sector's main challenge is shifting from funding shortages to restructuring its borrowing sources, driven by the need for stable funding as global risks increase.
Banks Become Key Lenders as Markets Cool
The sector's reliance on capital markets is declining, replaced by a growing reliance on bank loans. This offers more stable pricing than volatile bond markets. Bank lending to NBFCs increased significantly, growing by 19.1% in Feb 2026 from 6.4% a year earlier, showing this growing reliance. This mirrors past trends where NBFCs turned to banks when market funding became difficult or too costly. External Commercial Borrowings (ECBs) are also expected to remain low due to global uncertainties and currency volatility, reinforcing the focus on domestic funding. Bank loans are projected to form 44-45% of total NBFC borrowings by FY27, up from 43% in H2 FY26, contrasting with a slowdown in capital market funding.
Meanwhile, leading NBFCs show different market valuations, hinting at varied investor views on their stability. Bajaj Finance trades at a P/E of approximately 31.9x, SBI Card at 28.9x, and Cholamandalam Investment and Finance Company at 24.3x. M&M Financial Services trades at a P/E of 17.0x. India Shelter Finance Corporation, focused on affordable housing, targets a Return on Assets (ROA) of 8.25-8.5%, well above the industry average of 2-4%, showing they can price effectively in certain areas. However, rising government security yields, around 7.5% currently, put pressure on the cost of funds, with new loans often costing more than existing ones for some companies.
New Risks Emerge in Bank-Centric Funding
While the shift towards bank funding offers some stability, it also creates new concentration risks. NBFCs are becoming more dependent on a smaller group of bank lenders, whose own funding costs are rising due to competition for deposits and the need to increase their benchmark lending rates (MCLRs). This could lead to a chain reaction where banks, facing their own funding and profit pressures worsened by global tensions and deposit outflows, might become more cautious and raise lending rates to NBFCs. The containment of ECBs, while reducing currency risk, also means less diversification and more reliance on domestic banks. Furthermore, global uncertainty, shown by rising oil prices and a weakening rupee (around 95 vs. USD), can hurt borrower cash flow, especially in unsecured loans, possibly leading to worse loan quality. Costs related to potential loan defaults are expected to remain high for segments like microfinance and unsecured business loans, despite overall sector growth forecasts. The historically higher borrowing costs for NBFCs compared to banks, because they cannot accept public deposits, remains a long-term issue.
Outlook Remains Neutral Despite Challenges
India Ratings has a neutral sector outlook for NBFCs for FY26, forecasting loan growth to moderate to 18.5% year-on-year. Profitability is expected to remain healthy at 2.3-2.5% in FY27, according to ICRA, but this depends on managing credit costs and maintaining stable profit margins. Analysts caution that net interest margins may be at or near their peak, and margins could shrink as funding costs increase. The sector's success in managing higher borrowing costs, asset quality, and changing regulations will be key for continued performance through FY27.