A recent report in financial media has pointed out the stress in Indian NBFC sector.
The trigger for the concern was the fall in the stock of Bajaj Finance after its recent results.
What was the specific point of concern?
Non-performing assets (NPA) or bad loans.
Now NPAs were historically a problem associated with PSU banks. But now the situation has changed.
PSU banks have by and large cleaned up their balance sheets. The private sector banks, on the other hand, has seen a rise in NPAs. Now their NPAs are mostly under control although it needs to be carefully watched by investors.
The real problem is the non-banking financing company (NBFC) sector.
These companies have faced NPA issues over the years, especially those operating in the microfinance on gold loans.
But NBFCs operating in the consumer lending market were not seen as a risk by the Indian stock market. This was because consumers were paying back their small loans for the most part.
Well, the situation is no longer so sanguine.
The Nature of the Problem
To put it simply, there are pockets of bad loans all over the place in the NBFC sector.
It’s not a system-wide problem of the scale we saw back in 2018 in PSU banks but it’s serious enough that investors should pay attention to NPAs.
The specific pockets in which NPAs are growing in NBFCs are microfinance, credit cards, personal loans, and MSMEs.
The worrying thing is that these bad loans have not been caused by any negative macro impact. This is a problem inherent to the Indian economy. If macro issues like tariffs were to deal a blow to the economy, the situation could get worse.
As a recent media report has highlighted…
In the post-results analyst call last week, Bajaj Finance MD Rajeev Jain said 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.
That doesn’t sound good at all. If this is the situation at Bajaj Finance, India’s biggest NBFC, the NPA situation at the smaller ones is likely to be worse.
Our View
Back in November 2024, our Co-Head of Research, Tanushree Banerjee, who closely tracks India’s financial sector has written about this problem in the Profit Hunter.
Over the last six years the performance of PSU banks in India has improved dramatically. The focus on bringing down bad loans has brought the NPA levels to a multiyear low of 2.8% in 2024.
The low NPAs have had a benign impact on the capital adequacy ratio (CAR at 16.8%) and return on equity (RoE at 13.8%).
So, the Reserve Bank of India, in its 29th Financial Stability Report released in 2024, declared Indian banks absolutely stable.
The problem is that the Financial Stability Report is backward and not forward looking.
If it were, then the central bank should have warned about NBFCs complaining about over leveraged borrowers. The September 2024 quarter results gave away the stress building up in the banking system.
Entities like Bajaj Finance and Piramal Enterprises pointed to the rise in non-performing assets, for their tighter underwriting norms.
Concerns are especially mounting after seasoned banks like Kotak Mahindra Bank and IndusInd Bank reported elevated stress in unsecured loans.
The pain is more acute in NBFCs and small finance banks like Ujjivan Small Finance that focus on smaller-ticket loans.
The sharp rise in growth of unsecured loans, like personal loans, over last three years, was already a reason to get cautious about the possibility of NPAs. Especially once interest rates moved up.
Yet the regulator did not seem to be too worried about it.
Conclusion
Tanushree’s motto is… ‘To finish first you must first finish.’
Thus, if you are considering investing in NBFCs, the first thing you should look for is the NPA situation.
If bad loans are rising, if the company is not adequately provisioning for them, collections are not as strong as it should be, if the management doesn’t seem to be sufficiently serious about the situations… you should stay away from the stock.
In the long term, the NBFCs that are the most careful about the health of their balance sheets, will be the ones to thrive and create wealth for investors.
Be careful with this these stocks.
Happy investing.
Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here…
The website managers, its employee(s), and contributors/writers/authors of articles have or may have an outstanding buy or sell position or holding in the securities, options on securities or other related investments of issuers and/or companies discussed therein. The content of the articles and the interpretation of data are solely the personal views of the contributors/ writers/authors. Investors must make their own investment decisions based on their specific objectives, resources and only after consulting such independent advisors as may be necessary.