NBFC Stocks in Potential Distress?
In a significant shift, the non-performing assets (NPAs) in India's public sector banks reached a multiyear low of 2.8% in 2024. However, the spotlight has now turned towards the non-banking financing company (NBFC) sector, where companies operating in microfinance, credit cards, personal loans, and MSMEs are facing NPA issues.
A recent financial media report highlights a tale of three exchanges: one's a comeback, one's a turnaround, and one's under threat. The NBFC sector, unfortunately, finds itself in the latter category. The rise in NPAs in this sector is primarily due to deterioration in asset quality amid operational challenges, borrower-level leverage, and stress in unsecured retail portfolios.
The microfinance sector has seen a significant deterioration in asset quality, with the stressed pool (including SMA, GNPA, and restructuring) at about 5.9% as of March 2024. NBFCs active in consumer lending (credit cards, personal loans) are witnessing stress due to rising bad loans, which was not a major risk earlier. MSME loans have been identified as a stressed pocket with slow credit growth and cautious lending by banks and NBFCs due to asset quality concerns.
The operational stresses in microfinance, growing borrower defaults in unsecured retail segments, credit quality issues in MSMEs, and evolving regulatory norms collectively contribute to rising NPAs in the Indian NBFC sector across these specific pockets. The Reserve Bank of India's (RBI) harmonized and stringent regulatory framework for NBFCs, including forward-looking provisioning, higher capital requirements, and governance standards, has led NBFCs to increase their credit costs and provision coverage in response to actual and expected deterioration in asset quality.
Entities like Bajaj Finance and Piramal Enterprises have pointed to the rise in non-performing assets due to tighter underwriting norms. The fall in the stock of Bajaj Finance was a trigger for concern, due to an increase in Non-Performing Assets (NPAs) or bad loans. In the post-results analyst call last week, Bajaj Finance MD Rajeev Jain stated that 13 of the 17 industries the company tracks in the MSME sector are showing signs of a slowdown, while three others are showing signs of contraction.
Kotak Mahindra Bank and IndusInd Bank have reported elevated stress in unsecured loans. The Financial Stability Report, however, did not warn about the stress building up in the NBFC sector. Despite this, our Co-Head of Research, Tanushree Banerjee, wrote about this problem in the Profit Hunter in November 2024.
It is important to note that NPAs were historically a problem associated with PSU banks, but now the situation has changed, with private sector banks seeing a rise in NPAs. The performance of PSU banks in India has improved significantly over the last six years. The Reserve Bank of India declared Indian banks absolutely stable in its 29th Financial Stability Report released in 2024.
In conclusion, the Indian NBFC sector is currently facing stress, and it is crucial for regulators and NBFCs to address these issues to maintain the stability of the financial sector.
- The banking sector's focus has shifted from a decrease in Non-Performing Assets (NPAs) in public sector banks to the rising NPAs in the non-banking financing company (NBFC) sector.
- The microfinance sector, consumer lending, and MSME loans within the NBFC sector are collectively facing issues with deteriorating asset quality, stress, and operational challenges.
- Entities within the NBFC sector, such as Bajaj Finance and Piramal Enterprises, have acknowledged an increase in NPAs due to stricter underwriting norms.
- Kotak Mahindra Bank and IndusInd Bank have reported increased stress in unsecured loans within the NBFC sector.
- The Financial Stability Report did not initially warn about the accumulating stress in the NBFC sector, but issues were discussed in Profit Hunter in November 2024.
- Contrary to the past where NPAs were predominantly a problem in public sector banks, the private sector banks are now witnessing a rise in NPAs.
- To maintain the stability of the financial sector, it is essential for regulators and NBFCs to collectively address the current issues faced by the Indian NBFC sector.
