NBFCs set for stronger growth on cleaner balance sheets, FCNR (B) flow to banks

Non-banking financial companies (NBFCs) are entering FY27 with healthier balance sheets, easing asset quality pressures and the prospect of abundant banking system liquidity, creating favourable conditions for stronger loan growth, margin expansion and earnings recovery.

After navigating nearly two-and-a-half years of asset quality challenges across multiple retail lending segments, NBFCs have largely completed a phase of tighter underwriting and balance sheet clean-up. With macroeconomic risks receding and liquidity conditions expected to improve, the sector appears well positioned to enter the next growth cycle from a stronger fundamental base, according to a report by Motilal Oswal Financial Services.

A key catalyst is expected to be the increase in banking system liquidity following the Reserve Bank of India's measures to attract foreign currency non-resident (bank) [FCNR(B)] deposits. As banks receive incremental liquidity, they are expected to step up lending to NBFCs, improving funding availability and strengthening the latter's bargaining power in negotiating borrowing costs.

Over the past two quarters, the principal challenge for NBFCs has been the cost of funds rather than access to liquidity. Despite the easing interest rate environment, incremental borrowing costs continued to rise for many NBFCs and housing finance companies. Improved liquidity is expected to gradually moderate funding costs and support net interest margins.

Improving prospects

The improving macroeconomic backdrop has also strengthened the sector's outlook after geopolitical tensions in West Asia eased and crude oil prices retreated from recent highs. Lower crude prices are expected to reduce inflationary risks and ease pressure on the cash flows of commercial vehicle operators and micro, small and medium enterprises, which constitute key borrower segments for many NBFCs.

FY27 is expected to mark the beginning of a broad-based earnings recovery for the sector, supported by stronger credit growth, improving margin visibility and normalising asset quality. Cleaner balance sheets and improved liquidity are likely to support loan growth, while stable interest rates and moderating borrowing costs should aid margins. At the same time, easing stress in loan portfolios is expected to keep credit costs under control.

Unlike previous liquidity cycles, NBFCs are entering the current phase after an extended period of risk recalibration, tighter credit underwriting and portfolio clean-up. This is expected to make the next phase of expansion more sustainable, with growth backed by stronger balance sheets and improved risk management.

Within the sector, diversified lenders with the ability to allocate capital across multiple products are expected to benefit the most from improving liquidity and accelerating credit demand. Opportunities are also seen in the recovery of microfinance and micro-loan against property segments, while a weak monsoon and any renewed escalation of geopolitical tensions in West Asia remain key risks to the outlook.