Why Is Indian Financing Sector Booming?
Kotak Insights | Date 22/12/2023
The financing landscape of India is experiencing a shift.
It’s transitioning through changes in borrowing and lending patterns across various segments such as Non-Banking Financial Companies (NBFCs), housing financiers, and micro-financiers.
Let us have a closer look at the industry’s trends and understand how the markets can benefit from it.
Here are some interesting trends playing out in the Indian financing sector:
Low Credit Penetration, High Growth
Intriguingly, India's credit penetration, as measured by credit to gross domestic product (GDP) ratio, remains lower compared to other developing nations. This signals an untapped market potential for financing companies.
Systemic credit has grown at a modest rate, whereas systemic retail credit has witnessed a robust 14.3% compounded annual growth rate (CAGR) between financial years 2018 and 2023.
This acceleration is attributed to the focused approach of banks and NBFCs towards retail credit.
Rural India as a Growth Frontier
Rural India is a compelling growth frontier for financing companies.
Despite contributing 47% to the gross domestic product (GDP), rural areas receive only 8% of overall banking credit.
This stark contrast highlights a massive market opportunity for institutions to extend financial services into these untapped regions.
In fact, rural areas are already witnessing higher growth in retail lending as compared to urban areas.
For NBFCs in 2022, the year-on-year growth in loans sanctioned for rural areas stood at about 70% and that for urban areas stood at 65%.
Going forward, government initiatives for financial inclusion, coupled with increasing digital penetration, are expected to fuel credit delivery in rural areas.
NBFC’s Resilience
Even NBFCs have undergone a remarkable transformation, evolving into a significant player in the financial sector.
Their assets under management (AUM) have surged from Rs 2 trillion to over Rs 30 trillion by the end of the FY23.
It is their agility in providing last-mile funding and catering to underserved customer segments which positions NBFCs as a formidable force in India's credit landscape.
With that, let us now have a look at what sectors are driving this financing growth recently.
Retail Segment Dynamics
The credit growth industry is seeing industrial credit's share falling and retail and services segments gaining prominence.
The subdued capital expenditure, low commodity prices, and low asset quality contribute to the lower demand for industrial credit.
In contrast, the retail and services segments have experienced a surge, driven by robust consumer demand, lower non-performing assets (NPA), and healthier margins.
The adoption of technology and changes in consumer behavior have facilitated the NBFC lending business growth without significant physical infrastructure.
Forecasts indicate a robust CAGR of 13-15% for retail credit by NBFCs between FY23 and FY25.
Small HFCs: Profitable Venture
Next up we have housing finance companies (HFCs).
Interestingly, India's mortgage-to-GDP ratio, though lower compared to other developing countries, has exhibited significant improvement. From 6.5% in financial year 2009, it has risen to 12.3% in financial year 2023.
Factors such as rising incomes, improving affordability, urbanization, and the reach of financiers contribute to this positive trajectory.
This helps the businesses of small housing finance companies.
Small HFCs are in the focus due to their higher profitability metrics.
With a Return on Assets (RoA) ranging from 3.8-4.0% in FY23, small HFCs demonstrate higher net interest margins (NIMs) despite facing higher costs of funds.
The industry's profitability is expected to improve gradually, driven by factors such as increased business volumes, standardization, and digitalization in credit assessment.
With government support, central bank initiatives, and increasing demand for housing in tier-II and -III cities, affordable HFCs are poised for a healthy growth trend.
So, how can investors and traders enter this space?
Sector Investment and Trading Insights
As India's financing sector undergoes a transformative phase, investors and traders need to navigate this dynamic landscape with prudence.
Finance stocks are very closely linked to economy. This is because both - credit growth and margins - are dependent on GDP growth and interest rates.
NBFCs tend to have high non-performing assets when interest rates are high and economy is underperforming and vice versa.
Moreover, adverse fluctuations in financial markets or conditions in the economy can also cause a decline in an asset management company’s (AMC) assets under management and vice versa, having a direct bearing on its revenue and profitability.
Since finance companies also have to provision for potential bad loans, these provisions generally lower profits for the company.
So, the best time to buy finance stocks could be at the start of an economic expansion (for AMCs) or when the interest rates are lower (in case of NBFCs).
In all, the financing sector is witnessing great momentum and has the drivers for growth in place for the coming years.
So, yes, the financing sector is taking off. And investors and traders should pay heed to the above shifts while looking at financing companies.
One should also align their return expectations with the industry business fundamentals, financial health, and valuations.
The enticing growth prospects of the industry beckon, but a thoughtful approach is key to unlocking its full potential.
Which financing stock are you tracking? Let us know in the comments!
By the way, speaking of the financial sector, check out the BFSI Classic Basket to know how you can ride this growth story with smallcase. Click Here to know more.
Until next time…
Happy Learning!
Sources: Kotak Securities, Economic Times, IBEF, RBI, CRISIL
Disclaimer: This article is for informational purposes only and does not constitute financial advice. Investors should conduct their own research and consult with financial professionals before making any investment decisions. Read the full disclaimer here.
