The Non-Banking Financial Companies (NBFCs) sector is confronted with a critical issue: the persistent rise in funding costs. Recent data reveals a 10-15 basis points (bps) increase in funding costs in the initial quarter of the fiscal year 2023-24, with projections indicating a potential surge of 30-40 bps by the third quarter. This imminent challenge raises concerns about potential downgrades in earnings for NBFCs. Despite these challenges, NBFCs are actively formulating and executing diverse strategies to tackle and overcome this predicament. This article aims to explore these strategies, gathering insights from industry experts within the NBFC sector.
Understanding the Dynamics of Expenses
The surge in funding costs poses a formidable challenge for NBFCs, directly impacting profitability metrics such as net interest margins (NIMs) and overall earnings. With forecasts pointing towards a sustained increase in funding costs, NBFCs confront the looming threat of potential earnings downgrades. These downgrades not only present immediate risks to their financial well-being but also erode market credibility over time.
NBFCs to safeguard margins
It is crucial for NBFCs to proactively adopt measures to safeguard their margins and counteract the adverse effects of rising funding costs. Failure to do so could expose them to heightened market volatility and diminished investor confidence. Thus, by implementing strategic initiatives aimed at mitigating the impact of escalating funding costs, NBFCs can reinforce their financial resilience and maintain a competitive edge in an increasingly challenging operating environment.
Strategic Approaches to Preserve Profitability
Innovative strategies are emerging within the NBFC sector to address the challenge of rising funding costs. One such approach involves targeting creditworthy borrowers. Poonawalla Fincorp, under the leadership of Abhay Bhutada, MD, exemplifies this strategy by focusing on borrowers with high credit scores. By aligning risk-based pricing with borrowers' credit risk profiles, Poonawalla Fincorp ensures that its lending practices mitigate risks while maximizing returns.
This targeted approach enables the NBFC to manage lending risks effectively and optimize profitability, particularly in segments with lower default probabilities. Prioritizing creditworthy borrowers under Abhay Bhutada's leadership establishes a robust foundation for sustainable growth and financial stability.
Transition towards Risk-Adjusted Returns
Another key strategy adopted by NBFCs involves shifting from spreads to risk-adjusted returns. By ensuring that returns accurately reflect underlying risks, NBFCs can optimize profitability and maintain sustainable margins. This strategic shift emphasizes the importance of aligning returns with the inherent risks associated with lending activities. Prioritizing risk-adjusted returns enables NBFCs to allocate capital more effectively, manage risks, and enhance long-term financial resilience.
Proactive Measures and Adaptability
Leading players in the NBFC sector, such as Bajaj Finance led by Rajeev Jain, are taking proactive measures to address challenges arising from increased funding costs. Anticipating margin moderation in FY24 due to RBI rate hikes, Bajaj Finance exemplifies the readiness of NBFCs to navigate these challenges. Their proactive stance enables the implementation of preemptive measures to sustain profitability. By openly acknowledging potential margin pressures, NBFCs demonstrate adaptability and resilience. Proactive strategies, including prudent risk management, empower them to navigate market complexities and meet client needs effectively.
Conclusion
The escalating cost of funds poses a significant challenge for NBFCs, compelling them to adopt strategic measures to sustain margins and profitability. By leveraging insights from industry experts and implementing proactive strategies such as targeting creditworthy borrowers, transitioning towards risk-adjusted returns, and taking proactive measures, NBFCs can effectively navigate these challenges. This strategic approach positions them for sustainable growth and profitability in the evolving financial landscape.
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