Diversifying borrowing: How power-focused NBFCs can aid a sustainable energy transition

The recent 50 basis points rate cut by the United States Federal Reserve, signalling the end of its monetary tightening cycle, is likely to lower borrowing costs globally and benefit emerging markets raising foreign debt. This will also help emerging market corporations and financial institutions raise dollar-denominated capital from sustainable finance markets to finance the energy transition. In India, by diversifying borrowing through global sustainable finance markets, non-banking financial companies (NBFCs) can ease concerns of over-reliance on bank borrowings, especially for lending to the power sector.

India’s financial sector is moving towards green lending, with banks and NBFCs committing Rs24.8 trillion (US$296.65 billion) in loans to facilitate the shift to renewable energy by 2030. Rural Electrification Corporation Limited (REC), Power Finance Corporation (PFC) and the Indian Renewable Energy Development Agency Limited (IREDA) lead these commitments with combined pledges of Rs14 trillion (US$167.47 billion).

Lending to NBFCs can raise concentration risk within banks

With the rapid growth of NBFC lending to the power sector, concerns over concentration risk have emerged. Many NBFCs, especially those focusing on infrastructure and power, depend on bank borrowings. Bank loans to NBFCs increased more than four times to Rs3.08 trillion (US$36.84 billion) in FY2023. Similarly, incremental lending increased by Rs1.6 trillion (US$12.68 billion) in the first 10 months of FY2024, largely due to pricing differentials that made bank funding more attractive to NBFCs.

The Reserve Bank of India (RBI) has voiced concern over the growing exposure of banks to NBFCs. According to the RBI, exposures of the top 50 government-owned NBFCs, totalling Rs7.8 trillion (US$93.3 billion), accounted for 40% of the total corporate credit in the NBFC sector during FY2023, all linked to the power industry. This significant concentration introduces risks, as a downturn in the power sector or challenges faced by a few large NBFCs could have a ripple effect throughout the sector. This significant concentration introduces risks, as a downturn in the power sector or challenges faced by a few large NBFCs could have a ripple effect throughout the sector.

Furthermore, banks are the primary lenders to NBFCs. Their exposure extends beyond loans to include investments in debentures and commercial papers issued by these firms, thus, heightening contagion risk. As a result, due to their interconnected nature, difficulties experienced by major NBFCs shock the banking system.

To address these concerns, the RBI introduced new guidelines, tightening lending norms, including a 25% increase in risk weights for bank loans to NBFCs rated AAA to A (these ratings indicate high credit quality). However, this raises funding costs for NBFCs and limits bank exposure.

NBFCs diversifying their borrowing channels

Many larger NBFCs are increasingly turning to the bond market for funding. Bonds provide long-term capital and allow NBFCs to secure funds without depending entirely on banks. NBFCs raised more than 80% of the total bond market fundraising in FY2025. However, most issuances are in the domestic market, where NBFCs also compete with banks, public sector undertakings and large corporates, making domestic borrowing expensive.

Smaller NBFCs face challenges in accessing the bond market. Lower-rated or smaller NBFCs struggle due to their higher risk profiles and higher cost of bonds, which makes the bond market a less viable option. To address these challenges, small and mid-sized NBFCs are adopting co-lending models to diversify funding and reduce regulatory pressures. Under this model, NBFCs source loans while banks handle underwriting and provide most of the funds. Co-lending assets under management for NBFCs are approaching Rs1 trillion (US$11.96 billion), reflecting growing collaboration between NBFCs and banks.

In addition, a nascent private credit market is emerging through Alternative Investment Funds (AIFs), providing smaller NBFCs another capital-raising avenue. AIFs have grown significantly, with annual credit rising from Rs150 billion (US$1.79 billion) in FY2019 to Rs666 billion (US$7.97 billion) in FY2024, a 37% compounded annual growth rate. They raise money from domestic and global institutions and high-net-worth individuals, and channel this capital to low-rated firms, typically rated A and BB. This offers critical funding for smaller NBFCs struggling to secure traditional loans or issue bonds.

Besides the domestic market, NBFCs should also tap into the offshore bond market for cost-effective financing lines, given the reduction in global interest rates.

NBFCs should prioritise green borrowing lines to finance low-carbon infrastructure

The rate cut by the US Federal Reserve creates a favourable environment for large NBFCs to raise dollar-denominated bonds. This can help power-focused NBFCs in India access global sustainable finance markets and raise green debt. The rate cut will likely increase the inflow of foreign money into Indian markets and attract higher foreign direct investment, strengthening the rupee and potentially lowering domestic interest rates.

On the co-lending side, larger banks should aim to access green financing lines through sustainable finance markets to co-lend with smaller NBFCs for clean energy infrastructure projects. Co-lending allows banks to diversify their lending into small, ticket-size clean energy assets, where smaller NBFCs typically have more expertise. Collaboration helps banks and NBFCs enhance green financing while sharing the associated risks. Co-lending also helps diversify the concentration risk NBFCs face from the power sector.

Through the AIF route, environmental, social, and governance (ESG)-focused foreign portfolio investors can invest in India’s clean energy sector via green debt-focused AIFs. These funds can flow into power-sector NBFCs. This strategy not only boosts green investments but also expands the funding base for NBFCs, facilitating their involvement in clean energy initiatives.

As India pursues its energy transition, the role of power-focused NBFCs becomes increasingly vital. These NBFCs can support the transition to a more sustainable energy landscape by leveraging diverse funding sources and innovative financial models.

This article was first published in The Hindu BusinessLine.