Improving Liquidity, Falling Funding Costs and Strong Retail Credit Demand Position India's NBFCs for Sustainable Earnings Growth

India's Non-Banking Financial Company (NBFC) sector is entering what could be one of its strongest growth phases in recent years. After navigating regulatory tightening, elevated credit costs and cautious lending over the past few years, the industry is now benefiting from healthier balance sheets, improving asset quality, moderating borrowing costs and an increasingly supportive macroeconomic environment.

Recognising this transformation, Motilal Oswal Wealth Management Research has identified the NBFC sector as its "Sector of the Week", highlighting L&T Finance and Shriram Finance as its preferred investment ideas. The brokerage believes the sector is well positioned to capitalise on the next phase of India's credit expansion, supported by resilient consumer demand, improving liquidity and stronger risk management practices.

As economic activity continues to accelerate and financing demand remains robust across retail and MSME segments, NBFCs are expected to play an increasingly important role in India's financial ecosystem.

India's Credit Cycle Is Entering a New Phase

The Indian lending landscape has undergone a significant transformation over the past few years.

Following a period marked by tighter regulatory supervision, higher provisioning requirements and disciplined underwriting, most leading NBFCs have emerged with stronger financial positions.

According to Motilal Oswal, the sector now enters FY27 with:

Stronger balance sheets
Improved asset quality
Better collection efficiencies
Lower credit costs
Diversified funding sources
Enhanced risk management frameworks

Unlike previous credit expansion cycles, which were often driven by aggressive lending, the upcoming phase is expected to focus on profitable and sustainable growth.

Liquidity Environment Turns Favourable

One of the biggest positives for the sector is the improving liquidity environment.

Recent measures introduced by the Reserve Bank of India (RBI) to strengthen banking system liquidity are expected to indirectly benefit NBFCs.

These initiatives include:

FCNR(B) deposit-related measures
Forex swap facilities
Liquidity enhancement mechanisms

Analysts estimate that these measures could generate foreign currency inflows of nearly $40–50 billion during FY27.

Although the liquidity support is directed primarily toward banks, it is expected to improve overall credit availability and reduce funding costs across the financial system.

For NBFCs, this translates into:

Easier access to borrowing
Lower funding expenses
Improved lending capacity
Better net interest margins

Declining Funding Costs Support Profitability

Funding cost remains one of the most important drivers of profitability for lending companies.

Over the past few months, moderating government bond yields and stable interest rates have significantly improved funding visibility.

Lower borrowing costs allow NBFCs to:

Maintain healthy lending spreads
Expand loan books profitably
Protect operating margins
Improve return on equity

Companies with strong credit ratings and diversified borrowing sources are expected to benefit the most from this trend.

Retail Credit Demand Remains Strong

The outlook for retail lending continues to remain encouraging.

Motilal Oswal expects healthy demand across multiple lending categories, including:

Personal loans
Vehicle finance
Housing finance
Gold loans
MSME financing
Consumer loans
Secured retail lending
Rural credit

Rising consumer confidence, improving employment conditions and expanding economic activity continue to support sustained credit growth.

Unlike earlier cycles that were concentrated in a few segments, the current expansion appears broad-based across urban and rural markets.

Asset Quality Has Improved Significantly

One of the strongest positives for the NBFC sector is the improvement in asset quality.

After implementing tighter underwriting standards and strengthening collection mechanisms over the past two years, most leading NBFCs have reported:

Lower delinquencies
Better recovery rates
Reduced credit costs
Stable non-performing assets
Improved collection efficiency

This allows companies to shift their focus from repairing balance sheets toward accelerating loan growth.

The improved credit environment also enhances investor confidence in the sector's long-term earnings potential.

L&T Finance: Retail Transformation Gains Momentum

Motilal Oswal remains optimistic about L&T Finance, assigning a target price of ₹370.

The brokerage believes the company's strategic shift toward retail lending has significantly strengthened its business model.

Retail Business Drives Growth

Retail loans now account for nearly 98% of L&T Finance's total loan portfolio.

The company has built a diversified lending franchise across:

Personal loans
Gold loans
SME finance
Microfinance
Two-wheeler loans
Farm equipment financing

This diversification reduces concentration risk while improving long-term earnings stability.

Strong Financial Performance

L&T Finance delivered another healthy quarterly performance.

Key highlights include:

Profit after tax increased by around 29% year-on-year
Net Interest Income (NII) grew nearly 28%
Loan book expanded approximately 27%
Credit costs moderated
Retail asset quality improved

The company also continues to strengthen its digital lending ecosystem through strategic partnerships and technology investments.

Management expects secured lending to remain one of the key growth drivers over the coming years.

Shriram Finance: Diversified Franchise Supports Sustainable Growth

Motilal Oswal has also identified Shriram Finance as one of its preferred NBFC investments.

The brokerage has assigned a target price of ₹1,230.

Leadership Across Multiple Lending Segments

Shriram Finance has built one of India's most diversified lending platforms.

Its core businesses include:

Commercial vehicle finance
Passenger vehicle finance
MSME lending
Gold loans
Consumer finance

The company continues expanding its presence across underpenetrated markets in northern, central and eastern India.

This geographical diversification provides additional long-term growth opportunities.

MUFG Partnership Strengthens Funding

One of Shriram Finance's biggest strategic advantages is its partnership with Mitsubishi UFJ Financial Group (MUFG).

The strategic investment has significantly strengthened the company's:

Capital position
Funding profile
Credit rating outlook
Access to international debt markets

Management expects borrowing costs to gradually decline over the next two to three years through:

Liability repricing
Rating upgrades
Lower deposit costs
Improved debt market access

Lower funding costs are expected to support stronger profitability going forward.

Healthy Earnings Outlook

Motilal Oswal projects strong financial growth for Shriram Finance over FY26–FY28.

Expected growth includes:

Assets Under Management (AUM) CAGR: approximately 17%
Profit After Tax (PAT) CAGR: approximately 26%

These projections are supported by robust loan demand, improving operating efficiency and disciplined lending practices.

Macro Environment Becoming Increasingly Supportive

Several macroeconomic developments continue to strengthen the outlook for NBFCs.

Falling Crude Oil Prices

Lower energy prices reduce inflationary pressures and improve repayment capacity among borrowers.

Stable Interest Rates

A stable rate environment enhances funding visibility and supports lending margins.

Better Liquidity

Higher banking system liquidity improves funding access across the financial sector.

Strong Economic Growth

India's expanding economy continues to generate healthy demand for retail and business credit.

Rural Recovery

Normal monsoon conditions and improving rural incomes could support agriculture-linked lending.

Together, these factors create a favourable environment for sustainable credit expansion.

Risks Investors Should Watch

Despite the positive outlook, investors should continue monitoring several key risks.

These include:

Weak monsoon affecting rural cash flows
Rising crude oil prices
Geopolitical uncertainties
Inflation pressures
Regulatory changes
Higher funding costs
Slower economic growth

However, analysts believe the sector is far better prepared than during previous lending cycles due to stronger governance, better risk management and healthier balance sheets.

Why NBFCs Could Outperform Banks

Several analysts believe quality NBFCs could outperform traditional banks during the next credit cycle.

Key advantages include:

Faster loan growth
Higher operating flexibility
Strong retail franchise
Better customer reach
Focused product offerings
Digital lending capabilities

Companies capable of balancing growth with disciplined underwriting are expected to create significant shareholder value over the coming years.

Investment Outlook

The Indian NBFC sector appears well positioned to benefit from multiple structural tailwinds.

Improving liquidity, stronger balance sheets, resilient credit demand and supportive macroeconomic conditions create a favourable backdrop for sustained earnings growth.

As India's financial inclusion story continues to evolve, well-managed NBFCs are expected to remain among the key beneficiaries of expanding retail credit demand.