NBFC profitability improves but calls for caution

Asset quality of NBFC sector has improved as gross non-performing assets (NPAs) and net NPAs have declined in 2022 (as on March-end).

Non-banking financial companies (NBFCs) have weathered the pandemic well and improved their profitability, but they need to keep in mind the rising cost of borrowing. The Reserve Bank of India has said this in its 'Annual Trend and Progress Report' for 2021-22. Borrowing costs are currently on the rise due to the tightening of monetary policy measures by the Reserve Bank to control inflation.

The Reserve Bank has said that NBFCs with 'strong capital buffers', adequate provisions and sufficient liquidity are ready for expansion. However, NBFCs need to be cautious about raising borrowing costs as financial conditions tighten. This is the largest source of debt for NBFCs. Since May, the Reserve Bank has hiked the standard policy rate by 225 basis points to curb inflation.

Although banks have not yet increased the entire rate up to the marginal cost of funds rate of funds-based lending rate, NBFCs are not facing the full cost of lending more and are able to pass on most of the rate hike to their end customer. But going forward the situation may change.

Meanwhile, disruptions caused by the second phase of Covid-19 dampened demand and averted risk. Due to this, the balance sheet of NBFCs grew at a slow pace in 2011-2011. At the same time, they have also faced headwinds from banks, especially in the retail sector which has a strong hold in auto loans and gold loans.

Despite these circumstances, these lenders maintained strong capital buffers, adequate provisions and strong capital positions. The asset quality of the NBFC sector has improved as gross non-performing assets (NPAs) and net NPAs have declined in 2022 (up to March-end). According to Reserve Bank data, total NPAs of NBFCs have declined from 6 percent in March 2021 to 5.8 percent in March 2022. Net NPA has come down from 2.7 percent to 2.3 percent during this period.

While business conditions have improved, NPAs have declined during the period due to deferral of NPA upgradation norms by the Reserve Bank and better recoveries and new additions. The provision coverage ratio increased from 56.7 percent in March 2021 to 60.7 percent in March 2022. The asset quality of this sector has further improved till September. As per Reserve Bank's assessment, it will continue to improve further.

The asset quality of NBFCs is expected to improve further in the near term, as economic activity will strengthen, the RBI said. Tighter regulatory oversight, reclassification of asset quality standards and immediate corrective action will further enhance stability. 'On the regulatory front, scale-based regulation is expected to strengthen NBFCs and increase the scope for natural consolidation in the sector. The net profit of NBFCs will increase. The improvement in the first half of FY 2022-23 is primarily due to changes in fund-based income. While the operating costs increased sharply. Less provision for NPAs and interest expense on bank loans, there was a significant increase in net profit from inter-corporate deposits.'