The business environment is set to turn favourable for non-banking financial companies (NBFCs), thanks to two recent developments.
On 25 February, the Reserve Bank of India (RBI) eased risk-weight norms for bank lending to NBFCs, reducing it from 125% to 100%, effective 1 April. This move should lower capital adequacy ratio requirements of banks for such lending, freeing up more funds for NBFCs. The measure follows a 25-basis-point (bps) repo rate cut on 7 February and is expected to ease investor concerns about systemic growth.
A lower interest rate cycle benefits NBFCs relative to banks, as it erodes banks’ cost advantage from low-cost current and savings account (CASA) deposits, allowing NBFCs to compete more effectively.
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Potential beneficiaries among listed NBFCs would be M&M Financial Services Ltd and Cholamandalam Investment and Finance Co. Ltd. Their funding from banks has been in the range of 45%-50% of their total borrowings at least since the last four quarters to Q3FY25.
For competitors Bajaj Finance Ltd and Shriram Finance Ltd the metric is lower. Here, investors would closely monitor if benefit of lower cost of funds will be retained by these companies or passed on to their customers at least partially.
But more than the cost of funds, credit availability from banks is crucial for NBFCs to grow their loan books. Growth rate in bank lending to NBFCs had almost halved to 6.7% as of December compared to a year ago, according to RBI data. This sharp contraction was a result of RBI’s regulations to increase the risk weightage for bank lending to NBFCs in November 2023, which was aimed at curbing rapid growth in unsecured consumer credit.
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RBI’s steps could solve the problem of cost of borrowings for the entire sector. But tackling company-specific issues such as asset quality and consequent credit costs will continue to shape earnings and valuations of NBFCs.
For instance, M&M Financial has continued to suffer from worsening asset quality in Q3FY25 as net stage 3 loans as a percentage of total loans at 2% was higher sequentially and year-on-year by 41bps and 48bps respectively.
For Cholamandalam, this parameter was marginally higher by 6bps sequentially and year-on-year at 1.66% in Q3FY25. In effect, M&M Financial’s share price has declined 3% over the last year even as Cholamandalam stock delivered 30% returns.
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Going by the estimates of Mirae Asset Sharekhan, M&M Financial is trading at much lower relative valuation at 1.6x of P/BV for FY26E compared to 3.9x for Cholamandalam. The latter’s premium valuation could be owing to the strong RoE of 21.6% versus 14.6% for M&M Financial.