NBFCs Pass Higher Funding Costs to Retail Borrowers Despite Repo Rate Cuts
NBFCs are increasing retail loan rates despite repo cuts as funding costs surge, with AA-rated NBFCs paying 75 basis points more than corporates - the highest premium since March 2022. Tight liquidity and selective investor behavior force NBFCs to either absorb higher costs in margins or pass them to sub-prime borrowers. Despite RBI's cumulative 125 basis points repo rate cut since February last year, rate transmission remains incomplete due to structural funding challenges in the NBFC sector.
*this image is generated using AI for illustrative purposes only.
Non-banking financial companies (NBFCs) are facing mounting pressure from rising funding costs, prompting some to increase retail loan pricing despite recent repo rate cuts by the Reserve Bank of India.
Funding Cost Pressures Mount
The borrowing environment for NBFCs has deteriorated significantly, with the spread between NBFC borrowing costs and similarly rated corporates reaching concerning levels. According to India Ratings, this gap has widened to a four-year high.
| Rating Category | Cost Differential | Time Period |
|---|---|---|
| AA-rated NBFC vs Corporate | 75 basis points higher | As of 2025 end |
| Historical Context | Highest premium | Since March 2022 |
| Loan Tenure | Five-year loans | Current market |
Anil Gupta, senior vice president and co-group head at Icra Ratings, explained the market dynamics: "Each investor will have a cap on how much can be invested in the NBFC sector. At a time when liquidity is tight and credit growth is high, NBFCs are lining up to borrow. In such times, investors become selective in their lending to NBFCs and this also increases the bargaining power, increasing cost of funds for NBFCs."
Market Response and Rate Transmission
Despite the RBI lowering the repo rate by a cumulative 125 basis points since February last year, NBFCs are struggling to pass on benefits to borrowers. The 10-year benchmark bond yields closed at 6.65% on Friday, declining about 12 basis points since last year, but this hasn't translated to relief for NBFCs.
Soumyajit Niyogi, director at India Ratings & Research, noted the sector's response: "Some NBFCs have increased their lending rates, and in other cases, they have not reduced the lending rate at all. In most cases, NBFCs have started transferring this high cost of funds to the end borrower. And partly they have started absorbing this in their margins."
Impact on Sub-Prime Borrowers
NBFCs primarily serve the sub-prime segment where lending rates typically start from 12-13%. Niyogi highlighted the borrower impact: "Here, if you increase the rate by 1-1.5%, the borrower may not feel the impact, but it is a dent in their pocket."
Jaykumar Shah, CFO at HDB Financial Services, confirmed the transmission challenges during an analyst call post third quarter results: "While there was a rate cut which happened in December, that hasn't really translated much into lower cost of borrowing in most instances."
Sector Outlook
According to a research paper published in the October RBI Bulletin, monetary policy impulses are transmitted to NBFCs' borrowing and lending rates, albeit incompletely. The higher cost of funds faced by NBFCs represents a key impediment to effective rate transmission on the borrowing side.
While most NBFCs continue operating with lower profit margins in the intensely competitive market, the sector faces ongoing pressure to balance funding costs with customer retention in an environment where liquidity remains tight and investor selectivity continues to drive borrowing costs higher.
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