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NBFC Shifting to Bond Market for Financing
Context:
The Reserve Bank of India (RBI) is encouraging non-banking financial companies (NBFCs) to reduce reliance on banks. Consequently, NBFCs are increasingly accessing the bond market for funding, according to PRIME Database.
About NBFC shifting from banks to bond market:
- Rise in Bond Issuance: There has been a marked increase in NBFCs raising funds through bond markets.
- For many NBFCs, bonds now represent 35% to 40% of their total borrowings.
Factors driving NBFC shifting to bond market:
- Regulatory Changes: The Reserve Bank of India (RBI) raised risk weights on bank lending to NBFCs, making bank borrowing more expensive for them.
- Cost Efficiency: Bonds often provide cheaper financing compared to bank loans, especially for established NBFCs with good credit ratings.
- Diversification: NBFCs aim to reduce dependency on banks and diversify funding sources to improve liquidity and financial flexibility.
- Attractive Bond Market Rates: Favourable interest rates in the bond market make it an attractive option.
Impact of NBFC shifting to bond market:
- Opportunities for Retail Investors: The surge in bond issuance presents opportunities for retail investors, especially with the minimum investment limit reduced from approximately ₹1 lakh to ₹10,000.
- Cost of Capital: If bond yields are lower than bank interest rates, NBFCs may benefit from reduced borrowing costs; higher yields could increase financing costs.
- Liquidity and Flexibility: The bond market offers diverse funding sources, potentially enhancing liquidity and providing more flexible repayment structures.
- Risk Management: Accessing the bond market diversifies funding sources, reducing reliance on banks and mitigating risks during financial stress.
- Impact on Interest Rates: Increased NBFC participation in the bond market could influence overall market interest rates, potentially raising them if demand rises significantly.
- Strong Opportunities in Corporate Bonds: Corporate bonds, particularly those maturing in three to five years, offer significant opportunities, with AAA-rated bonds yielding around 7.5%, well above expected inflation.
Risks associated with higher Bond market investment:
- Interest Rate Risk: If the RBI raises rates, the value of existing bonds declines, with longer-term bonds being more sensitive to these changes.
- Credit Risk: Lower-rated bonds carry a higher credit risk, including potential downgrades in ratings due to worsening financial conditions.
- Liquidity Risk: Lower-rated bonds may be difficult to sell, impacting liquidity for investors.
- Reinvestment Risk: If bonds mature or are called back early, reinvesting may not be possible at the same rate, especially in a low interest-rate environment.
- Market Volatility: The bond market is more prone to fluctuations than bank loans, particularly during economic uncertainty impacting NBFCs’ ability to secure favourable borrowing terms.
Way Forward for investing in Bond market:
- Evaluate Credit Ratings: When assessing bonds, consider the credit rating, ideally AA or higher, as higher ratings indicate lower default risk.
- Review Issuer’s Financials: Examine the issuer’s financial health, including debt levels, and note who else is lending; involvement of major lenders suggests thorough due diligence.
- Interest Rate Type: Consider whether the bond’s interest rate is fixed or floating, as this impacts returns in a changing rate environment.
- Shorter Maturities Preferred: Avoid bonds with long maturities; a tenure of one to two years is recommended to minimise default risk.
- Watch for High Returns: Be cautious with bonds offering returns above 12%, as such rates may indicate a red flag.
