Shadow Banks in India Face Higher Borrowing Costs

Indian shadow banks, also known as Non-Banking Financial Companies (NBFCs), are set to face increased costs for borrowing money through bonds. This comes after the Reserve Bank of India (RBI), the country’s central bank, introduced tighter regulations in November 2023. These regulations require banks to set aside more money as reserves against loans given to NBFCs and for unsecured loans in general. The aim is to control the rapid rise of consumer debt in India.

RBI Tightens Regulations, Banks Reduce Lending to NBFCs

The impact of the RBI’s measures is already being felt. Banks are lending to NBFCs at a slower pace. According to the latest RBI data, bank lending to NBFCs grew by only 14.7% in February 2024, compared to 31.9% a year earlier. This significant slowdown indicates a reduced appetite among banks to lend to shadow banks.

Kotak Mahindra Bank Predicts Rise in Borrowing Costs

Kotak Mahindra Bank, one of India’s leading financial institutions and a major player in the bond market arrangement, predicts that NBFCs will have to pay more to borrow money. Sujata Guhathakurta, President of Debt Capital Markets at Kotak Mahindra Bank, expects borrowing costs for NBFCs to rise by up to 30 basis points. This increase is likely to be even steeper for lower-rated NBFCs, particularly those that specialize in unsecured personal loans.

NBFCs to Rely More on Bond Market, Potential for Higher Bond Yields

With banks lending less, Kotak Mahindra Bank anticipates that NBFCs will turn more towards the bond market to meet their funding needs. This increased demand for bonds issued by NBFCs could lead to a rise in credit spreads. Credit spread refers to the extra yield that investors demand to hold a corporate bond compared to a government bond with a similar maturity. In simpler terms, NBFCs will likely have to offer investors higher interest rates on their bonds to attract them.

Early Signs of Rising Borrowing Costs

There are already signs that NBFCs are paying more to borrow. The difference in yield between AAA-rated five-year bonds issued by shadow banks and government bonds has widened to 65 basis points in April 2024, compared to 55 basis points in November 2023, when the RBI introduced the new regulations. This widening spread indicates that investors are demanding a higher premium to hold NBFC bonds. The spread is even larger for lower-rated NBFCs, with AA-rated issuers seeing a spread of 138 basis points for similar maturing bonds.

Conclusion

The stricter regulations imposed by the RBI are making it more expensive for shadow banks in India to borrow money. With banks lending less and the bond market demanding higher yields, NBFCs face an uphill battle in terms of securing funding. This could have a ripple effect on the Indian financial sector, as NBFCs play a crucial role in providing credit to individuals and businesses. It remains to be seen how NBFCs will adapt to this new environment and how it will impact the overall credit availability in India.

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. The information is based on various secondary sources on the internet and is subject to change. Please consult with a financial expert before making investment decisions.