Credit Crunch: NBFCs face sharp decline in loan sanctions

Despite its impressive GDP growth rates, India's high fiscal deficit and stagnant private investment raise concerns about long-term sustainability of the economic expansion.
Despite its impressive GDP growth rates, India's high fiscal deficit and stagnant private investment raise concerns about long-term sustainability of the economic expansion.

Loan sanctions by Non-Banking Financial Companies have fallen significantly. The growth in credit sanctioned by NBFCs dropped to 5.7% year-on-year in the April-June quarter of FY24, compared with a more than 100% year-on-year growth in the same quarter of the previous year. This decline can be attributed to the higher base effect from the previous year. However, a sharp decrease in home loan sanctions has also hindered growth in the first quarter of this year.

Last year, the industry experienced exceptional growth as it catered to a pent-up demand after a prolonged slump during the pandemic years. However, higher interest rates in the system this year have dampened the demand for home loans. This does not apply to the growth in unsecured loans and gold loans, which have remained steady on a year-on-year basis.

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Sanctioned credit shrank 20.3% over the January-March quarter, the fourth quarter of FY23. In absolute terms, non-banking finance companies sanctioned Rs 3.51 trillion worth of loans in Q1FY24, compared with Rs 3.32 trillion in Q1FY23. Sequentially, this marked a decrease from Rs 4.41 trillion sanctioned in Q4FY23. Furthermore, the sanctions in Q1FY24 were lower than the four-quarter average of 3.84 trillion in FY23.

Notably, not all categories are witnessing a decline. There has been significant growth in gold loans growing at 47.7% year-on-year, automobile loans at 15.1% year-on-year, and equipment loans at 16.3%. Conversely, areas such as commercial vehicle loans reported a negative growth of 2.8%, housing loans saw a decrease of 26.6% year-on-year, and property-backed loans and secured business loans also exhibited negative growth, as reported by the Finance Industry Development Council (FIDC) in a statement on Monday.

The role of NBFCs

Compared with their private counterparts, shadow banks are financial intermediaries that participate in creating credit. However, unlike private sector players, they are not subject to strict regulatory oversight. Since shadow banking is generally unregulated, it is not subject to the same kinds of risk, liquidity, and capital restrictions as traditional banks. While the shadow banking system played a major role in the expansion of housing credit leading up to the 2008 financial crisis, it poses potential risks to the global financial system.

The only argument in favour of shadow banks is that they reduce dependency on traditional banks as a source of credit. Thus, shadow banks also play a role in the economy as an additional source of lending, providing diversification in the financial system.

Over time, Indian shadow banks have evolved, and NBFCs now dominate the credit financing landscape. The connotation of “non-bank” has faded, according to industry leaders. Initially, the idea was to position NBFCs as institutions that could provide an alternative to banks on a smaller scale. However, the industry has progressed in such a way that industry insiders believe shadow banks have overshadowed traditional banks.

In fact, the valuations of NBFCs like Bajaj Finance and Cholamandalam Finance even surpass those of leading banks. According to a review of the NBFC sector by the Boston Consulting Group, as of the end of May 2023, Bajaj and Cholamandalam had price-to-book ratios of 8.2 and 6, respectively. In comparison, it was 3.2 for HDFC Bank, 3.6 for the former HDFC, and 1.7 for SBI. BCG notes that so-called “diversified” NBFCs, active in several sectors, command higher valuations.

In an opinion article published by Policy Circle, Dakshita Das argued that NBFCs should be seen as partners in the traditional banking system rather than competitors. She adds that within the vast ecosystem of the financial world, NBFCs play a unique role within their respective sectors. However, to make NBFCs more efficient, regulation will play a pivotal role in ensuring responsible and accountable functioning. To achieve this, regulatory authorities must undertake regular monitoring, inspections, and audits of NBFCs to ensure adherence to established rules and standards.

NBFCs reported annualised growth of 11.6% year-on-year in rural areas, 12.4% year-on-year in semi-urban areas, and 2.2% in urban areas. Nevertheless, all three showed negative growth in Q1FY24 compared to sanctions in Q4FY23. It is expected that growth in loans, especially to businesses and industries, will pick up from the third quarter starting October 2023.

The RBI is currently considering whether to allow shadow banks to take deposits. The decision is a complex one, and there are strong arguments on both sides. The hesitation on the part of the RBI stems from the fact that shadow banks are often not subject to the same level of regulation as traditional banks, which can lead to higher risks for borrowers and lenders.

These institutions are more opaque than traditional banks, which can make it difficult to assess their financial health. A failure of a shadow bank could have a negative impact on the financial system as a whole. Ultimately, the RBI will need to weigh the potential benefits and risks before taking a decision.