Non-Banking Financial Companies (NBFCs) play a critical role in India’s credit ecosystem by extending financing to underserved segments such as MSMEs, retail borrowers, and infrastructure-linked sectors. However, NBFC funding in India remains complex, shaped by liquidity risks, regulatory oversight, and market cycles. For NBFCs, lenders, and institutional investors, understanding funding structures and associated risks is essential to navigating
India’s evolving fixed-income markets. This article examines the NBFC funding landscape, key challenges, primary funding sources, and the structuring approaches commonly used in practice.

Overview of the NBFC Funding Landscape in India

Unlike banks, NBFCs do not have access to retail deposits and rely largely on wholesale funding. This structural difference makes NBFCs more sensitive to market sentiment and liquidity conditions. Over the past decade, the NBFC sector has expanded significantly, with assets under management exceeding ₹40 lakh crore. This growth has been accompanied by tighter regulatory oversight from the Reserve Bank of India (RBI), particularly after liquidity stress events in 2018–2019 exposed vulnerabilities in funding and asset–liability management practices.

Key characteristics of the NBFC funding landscape include:
● Diverse funding sources, including bank borrowings, bonds, securitisation, and institutional credit
● Tiered market access, where larger, higher-rated NBFCs enjoy broader and cheaper funding options
● Market-driven pricing, closely linked to credit ratings, asset quality, and investor sentiment
● Regulatory differentiation, driven by RBI’s scale-based framework introduced in 2022

Key Challenges in NBFC Funding

Liquidity Constraints

NBFCs face structural liquidity risk due to their dependence on market-based funding. Unlike banks with stable deposits, NBFCs must refinance obligations regularly through debt markets. During periods of stress, investor risk aversion can sharply restrict access to capital.

Liquidity stress typically arises from:

● Market disruptions limiting fresh borrowing
● Concentrated maturity profiles
● Reduced investor appetite for lower-rated NBFC paper

The IL&FS episode demonstrated how confidence-driven shocks can quickly affect even
systemically important NBFCs.

Asset–Liability Mismatch (ALM)

Many NBFCs lend long-term while borrowing short-term, creating refinancing risk. This mismatch can force distressed borrowing or asset sales during market dislocations.

Common ALM challenges include:

● Difficulty matching asset tenors with funding tenors
● Exposure to interest rate volatility
● Margin pressure during refinancing cycles

While RBI mandates ALM monitoring and stress testing, structural mismatches remain inherent to several NBFC business models.

Regulatory Requirements

Regulatory expectations for NBFCs have increased materially, especially under the scale-based regulation framework. Larger NBFCs face enhanced capital, liquidity, and governance requirements, while smaller entities contend with rising compliance costs and operational complexity.

Primary Funding Sources for NBFCs

Bank Borrowings

Banks remain a core funding source for NBFCs, offering term loans, working capital facilities, and credit lines.

Advantages
● Relationship-based funding
● Operational flexibility
● Competitive pricing for highly-rated NBFCs

Challenges
● Concentration risk
● Shorter funding tenors
● Exposure limits restricting scale

Bonds and Non-Convertible Debentures (NCDs)

Bond markets are increasingly important for NBFC debt funding, particularly for larger and well-rated issuers. Bonds allow NBFCs to diversify funding sources and access longer-tenor capital.

● Public issuances involve higher disclosure and regulatory requirements
● Private placements dominate institutional participation due to speed and flexibility

Sustainable bond market access typically requires a minimum rating of AA– and consistent disclosure standards.

Alternative Investment Funds (AIFs)

Credit-focused AIFs provide flexible, structured funding to NBFCs, particularly those with
limited access to public bond markets.

Characteristics include:
● Customized structures
● Higher pricing
● Strong covenant and monitoring frameworks

Securitisation

Securitisation enables NBFCs to convert loan pools into marketable securities, improving liquidity and capital efficiency.

Key benefits:
● Off-balance-sheet funding
● Risk transfer to investors
● Portfolio-specific pricing

The RBI’s revised securitisation framework has standardized risk retention and disclosure requirements.

Real-World Structuring Approaches

Secured Structures

Post-2018, secured lending has become the dominant approach in NBFC funding.

Common structures include:
● Asset-backed lending
● Receivables-based financing
● Escrow-controlled cashflow structures

These mechanisms provide downside protection for lenders while improving funding access for NBFCs.

Credit Enhancement

Credit enhancement techniques improve investor confidence and pricing outcomes, including:

● Overcollateralisation
● Subordination
● Partial guarantees
● Cash collateral support

Cashflow-Based Lending

This approach focuses on predictable portfolio cashflows rather than balance sheet size. It involves:

● Detailed cashflow modelling
● Performance-linked covenants
● Ongoing portfolio monitoring

Co-Lending Arrangements

Bank–NBFC co-lending structures allow risk sharing and access to lower-cost capital, while enabling NBFCs to scale originations without excessive balance sheet strain.

Role of Institutional Investors

Institutional investors form the backbone of NBFC debt markets:
● Mutual funds focus on short- to medium-term instruments
● Insurance and pension funds prefer long-tenor, highly-rated bonds
● AIFs and debt funds provide flexible capital across the risk spectrum

Debt market infrastructure, including rating agencies, electronic platforms, and clearing systems, supports transparency and settlement efficiency.

Key Risks for Lenders and Investors

Investors in NBFC debt must evaluate:
● Credit quality and underwriting standards
● Liquidity and refinancing risk
● Structural protections and legal enforceability
● Regulatory compliance and governance
● Market-driven spread volatility

Conclusion

NBFC funding in India increasingly depends on diversification, disciplined structuring, and robust risk management rather than reliance on any single funding source. While banks provide foundational liquidity, bond markets, securitisation, and structured credit play a
growing role in improving funding resilience and ALM alignment. For NBFCs and institutional participants alike, understanding these dynamics is essential to navigating India’s evolving debt markets.