NON-BANK finance companies (NBFCs) are likely to rely more on banks for their funding requirements as interest rates are hardening in the capital market, says a report.

As the sector moves towards banks for meeting its funding requirements, smaller NBFCs could witness a sharp increase in their funding costs, India Ratings and Research said in a report. “The borrowings of non-bank finance companies (NBFCs) could get skewed to banks in FY23, given the hardening of rates in the capital markets,” the agency said in a report on Wednesday.

The shift in the NBFCs funding mix in FY23 will be driven by a rise in the proportion of short-term funding by way of commercial papers and debenture funding getting replaced by bank funding to a certain extent. A huge quantum of borrowings to be raised by large NBFCs would lead to a further increase in the banks’ exposure to the sector, and small NBFCs thus could face crowding out, the report said.

The agency said with the rise in interest rates, following a 90 basis points (bps) increase in repo rate by RBI in two tranches, NBFCs would see a faster increase in the incremental funding cost than that for banks on account of their institutional funding. Around one-third of the NBFCs borrowings would come up for refinancing in FY23, it noted.

Furthermore, bank funding on the NBFC balance sheet is mostly floating in nature and would also witness upward repricing.

However, the agency said that the Marginal Cost of Funds based lending Rate (MCLR)-linked funding would see a lagged increase in cost compared to the borrowings linked to market benchmarks such as repo and T-Bill.

The report said the increase in rates could lead to a 90-100 bps year-on-year rise in funding cost in FY23. There could be some pass on of the rise in select few segments.

The agency said the prevailing uncertain operating environment has led NBFCs to maintain excess liquidity on the balance sheet in the range of 5-10 per cent of assets, which impacted the profitability due to the negative carry of excess liquidity.