NBFC stocks in focus: Rising funding costs threaten margins despite robust loan growth and asset quality

The NBFC (non-banking financial company) sector is expected to report healthy earnings for the September 2026 quarter, supported by robust credit demand, steady loan growth and stable asset quality. However, the operating environment may get tougher in the second half of Financial Year (FY) 2026-27 as higher interest rates push up funding costs.

The Reserve Bank of India’s (RBI) recent 25 basis point repo rate hike, along with its shift to a ‘calibrated tightening stance’, suggests more interest rate hikes may be on the way. Analysts expect another 50 basis points of rate hikes during the rest of the year.

Funding costs are a key variable for NBFCs because they depend heavily on bank borrowings, bonds, commercial papers and other market instruments to fund their loan books. As interest rates move up, borrowing becomes more expensive, pushing up both fresh funding and refinancing costs.


Early signs of this are visible. “Incremental cost of funds for NBFCs continued to inch up in the second quarter of FY27, particularly for lenders with greater reliance on market borrowings, as bond yields remained elevated amid geopolitical uncertainty,” noted Motilal Oswal Financial Services in a recent earnings preview report. In simple terms, NBFCs that raise more money through bonds and commercial paper are paying more for every fresh rupee they borrow.

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Higher borrowing costs could gradually squeeze net interest margins (NIMs), a key indicator of lending profitability. NIM measures the spread between what a lender earns on loans and investments and what it pays on borrowings. Ishank Gupta, Analyst, Banking and Financial Services, Choice Institutional Equities, expects sector-wide NIM compression of 10-20 basis points over the next two to three quarters. The impact, however, is unlikely to be uniform. Much will depend on an NBFC’s funding profile, liability structure and ability to pass on higher borrowing costs to customers.

For investors, the bigger question is not just how NBFCs perform in the September quarter, but how well they manage a potentially tougher operating environment. Their ability to contain funding-cost pressures while preserving growth and asset quality will be critical in the coming quarters.

Sharp rebound

Growth remains healthy

Despite concerns around rising rates, the sector’s growth drivers remain intact. Over the past few years, NBFCs have benefited from strong credit demand, better asset quality, healthy capital positions and broader funding sources. Business updates from several major players for the September 2026 quarter suggest growth remains broad-based, with healthy disbursements across housing, vehicle finance, gold loans and unsecured lending.

The sector has also benefited from a surge in banking system liquidity following the RBI’s special dollar-rupee swap facility linked to FCNR(B) deposits. Banks mobilised $127.2 billion through these deposits, easing liquidity conditions and supporting funding availability for NBFCs.

Against this backdrop, growth expectations remain strong. A recent Nuvama report expects several large retail and diversified NBFCs to maintain loan growth of 20-25% in the near term, supported by healthy credit demand and stable asset quality.

Pressures emerging

While liquidity remains comfortable, it does not completely offset the impact of a rising rate environment. According to Nuvama, funding costs are likely to edge up as surplus liquidity normalises, which could start weighing on margins from FY2027-28.

Analysts also point to the sharp increase in bank lending to NBFCs after the RBI’s February 2025 risk-weight reduction. JM Financial estimates that bank credit to NBFCs grew 27% in FY2025-26, compared with about 6% in the previous year.

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This matters because bank loans are usually linked to benchmarks such as the repo rate or EBLR (external benchmark lending rate) and are repriced relatively quickly. As a result, higher policy rates could be transmitted faster to NBFC borrowing costs than in previous cycles.

Not all lenders are equally vulnerable. NBFCs with a larger share of floating-rate loans and relatively stable liabilities are generally better placed to navigate a rising rate environment. Floating-rate assets allow them to pass on higher rates to borrowers more quickly, while fixed-rate liabilities help delay the impact of rising funding costs.

Housing finance companies may be relatively better positioned because a large proportion of their loan books are linked to floating rates. In contrast, lenders with a higher share of fixed-rate assets could face greater pressure on margins.

“Vehicle financiers, MFIs (microfinance institutions) and diversified NBFCs carry a larger fixed-rate book on the asset side and are expected to witness relatively higher margin pressure,” says Meghna Luthra, Research Analyst, InCred Capital Wealth Portfolio Managers. Another area investors are watching closely is the IRDAI’s consultation paper on insurance distribution reforms. If implemented as proposed, the commission caps could reduce insurance distribution income for some NBFCs and weigh on profitability.

Valuations are reasonable

NBFC stocks have faced pressure this year amid geopolitical uncertainties, inflation concerns and the proposed IRDAI reforms. On an equal-weighted basis, the 60 NBFCs in the BSE Financial Services Index have declined 4.5% so far in 2026, with 43 stocks (or 72%) generating negative returns. The analysis is based on 13 October 2026 closing values. Analysts believe the correction reflects broader macro concerns rather than any significant deterioration in operating fundamentals. They also point out that valuations have become more reasonable after the recent decline.

Vinod Nair, Head of Research at Geojit Investments, says valuations have moderated to fair levels following a sector-wide de-rating that has been driven more by regulatory developments than interest-rate concerns. That said, investors should avoid viewing the sector as a blanket bargain.

“Valuations need to be assessed against sustainable return on equity, growth visibility, asset quality and funding resilience,” says Thomas J. Priju, Portfolio Manager, Karma Capital.

Analysts recommend focusing on lenders with strong capital positions, stable asset quality and diversified funding sources. Rather than chasing stocks that have corrected the most, Priju advises investors to assess whether current valuations adequately compensate for the underlying earnings risks and growth outlook.

Gupta advocates a selective and staggered approach with a two-to-three-year investment horizon. In a tightening-rate environment, balance-sheet strength should matter more than aggressive AUM growth or high lending yields. He also believes diversified lenders are likely to be better positioned than those heavily dependent on a single lending segment. Here is how the three NBFC stocks with the most ‘buy’ ratings on Bloomberg are placed:

Banking on a rally

Shriram Finance

*Diversified lending franchise and resilient asset quality provide a cushion against evolving macroeconomic headwinds.

*The partnership with MUFG Bank is expected to lower funding costs over time.

Cholamandalam Investment and Finance Company

*Stable asset quality across lending segments and continued market-share gains are expected to support long-term growth.

*A gradual shift towards consumer loans and higher-yielding gold loans is improving the business mix and portfolio quality.

Home First Finance Company

*Higher average ticket sizes compared with peers help the affordable housing financier maintain better productivity and cost efficiency.

*According to a recent Asit C. Mehta report, strong technology adoption, operating leverage, improving efficiency, credit-rating upgrades and lower funding costs remain key positives.

Stocks mentioned are not recommendations. Consult your financial adviser.