India's shadow banks are bracing for a cost spike and a credit squeeze

The Reserve Bank of India (RBI), on November 16, increased the risk weights on unsecured loans including credit card dues.

While this is applicable for all lenders, the non-banking financial companies (NBFCs), or shadow banks, in India are more vulnerable to the rise in the cost of funds resulting from the RBI decision.

For instance, Home First Finance said that the capital adequacy ratio -- the buffer money that lenders keep to cover for possible defaults -- will worsen by 100-200 basis points. One basis point is one-hundredth of a percentage point or 0.01%.

Similarly, SBI Cards, with a credit card RWA of 100%, will feel the impact along with other NBFCs. according to CNBC-TV18 analysis.

This is because these shadow banks have seen a big spurt in lending, particularly in the unsecured segment, in recent months.

Umesh Revankar from Shriram Finance, Nitin Chugh from State Bank of India (SBI), Suresh Ganapathy, a Banking Analyst at Macquarie Capital Securities, and Jinay Gala from India Ratings and Research collectively evaluated the repercussions on NBFCs, fintechs, and overall credit growth.

“As a percentage of the last 12 months incremental credit, almost 15% has gone to the NBFC space. That is a significant amount,” Ganapathy said. That's nearly one out of every ₹6 lent in the last year has gone from the NBFCs.

An unsecured loan is granted without the need for collateral.

The FIDC, representing NBFCs, has written to the RBI, requesting the removal of the heightened risk weight on bank loans. "Replacing this kind of funding through capital markets remains a quite dicey thing because NBFCs are also growing in size and scale and their incremental requirements would increase. So if the banks start to curtail their exposure to NBFCs, there could be a pricing markup on the cost of funds for NBFCs. Also, their ability to borrow from the capital market is limited,” Jinay Gala told CNBC-TV18.

Since NBFCs rely on banks for a big chunk of their funds, even the bigger banks may not be completely immune to any crisis in the NBFC segment.