NBFCs Lead Credit Expansion Amidst Evolving Regulations and Funding Diversification

India's Non-Banking Financial Companies (NBFCs) are expanding credit faster than banks. Projections show NBFCs growing 15-17% in FY26, far exceeding the banking sector's estimated 10.4-11.3%. NBFCs' total credit book doubled from ₹24 lakh crore in 2021 to ₹48 lakh crore by March 2025. They are expected to reach about ₹70 trillion in assets under management by FY27, highlighting their growing role in lending.

NBFCs Lead in Key Lending Segments

NBFCs' growth is fueled by strong positions in retail and Micro, Small, and Medium Enterprises (MSME) lending. They dominate micro-Loans Against Property (LAP) and are key MSME lenders, with MSME AUM projected over ₹5.3 lakh crore by FY26. NBFCs are also aiming to regain market share in gold loans by expanding branches. Lending to the services sector is their fastest-growing area, up 29.8% year-on-year, outperforming industrial and retail loans. This shows NBFCs effectively serve a wide range of borrowers, including those overlooked by banks.

Adapting to Evolving RBI Rules

The Reserve Bank of India (RBI) is updating rules for NBFCs. Starting July 1, 2026, some low-risk entities, called 'Unregistered Type-1 NBFCs', won't need mandatory registration if they don't use public funds, have no direct customer contact, and have assets under ₹1,000 crore. This tiered system aims to ease compliance for some firms while letting supervisors focus on larger, more critical ones. The RBI also adjusted risk weights for NBFC loans to infrastructure projects, providing capital relief for older assets. It reversed a previous increase in risk weights for microfinance loans, which should reduce costs for NBFC-MFIs. A new system based purely on asset size is expected to place more lenders under tighter supervision as they grow.

Diversifying Funding Sources

Banks are still NBFCs' main funders, but this reliance is lessening. After the RBI raised risk weights on bank funding for NBFCs in November 2023 (from 100% to 125%), NBFCs are seeking more diverse funding. They are increasingly using non-convertible debentures (NCDs), commercial papers (CPs), securitization, and international bonds, especially well-rated firms. This diversification helps reduce risks and improve stability, as NBFCs are more vulnerable to funding issues than banks with their steady deposit bases.

Risks and Challenges for NBFCs

Despite growth, NBFCs face significant risks. Credit risk is a concern, particularly in unsecured loans and MSME segments, with some areas showing rising delinquencies. Liquidity risk is constant, as NBFCs rely on market funding that can become costly or unavailable during stress. Their funding structure makes them more sensitive to interest rate changes than banks, potentially squeezing profit margins. Macroeconomic risks from geopolitical events like conflicts could increase oil prices, affecting inflation, GDP growth, and market stability, which in turn impact lending and asset quality. Increased regulatory oversight on larger NBFCs will also require higher capital reserves and compliance.

Analyst Outlook and Growth Prospects

Analysts expect strong growth for NBFCs, supported by consumer demand, MSME lending, and formalization in areas like gold loans. Co-lending with banks is growing, helping NBFCs use their distribution reach while reducing balance-sheet risk. However, analysts recommend a cautious, selective investment approach. Some note that the earnings growth advantage NBFCs used to have over banks is shrinking, possibly affecting valuations. While well-managed and diversified NBFCs are likely to show good compound annual growth rate (CAGR) returns, investors should watch profit margins due to rising funding costs and possible earnings downgrades. NBFCs' ability to adapt to regulations and diversify funding, along with their past resilience, positions them as key players in India's financial sector.