Over the past decade or so, NBFCs have increasingly adopted a “growth at all costs” strategy, particularly in newer as well as in relatively riskier credit segments such as microfinance and unsecured MSME lending, EV financing, and rooftop solar financing. These are segments that are still evolving, have limited historical data, and inherently higher execution and credit risks.
A key driver of this behaviour is the funding constraint faced by early-stage and smaller NBFCs. Bank debt is typically unavailable to NBFCs operating at a small scale or with lower credit ratings. As a result, such NBFCs are forced to rely on a narrow set of high-cost NBFC or alternative lenders. This, in turn, pushes them toward credit segments that can absorb higher lending rates, reinforcing concentration in riskier asset classes.
To access lower-cost funding from banks or from development finance institutions, NBFCs generally need to reach a minimum scale of around INR 1,000–1,500 crore in assets or alternatively maintain very low leverage supported by substantial equity (often INR 500 crore or more). Credit rating upgrades, which are critical for funding access, are themselves contingent on achieving this scale or equity depth.
Consequently, NBFCs are incentivised to raise large amounts of equity early in their lifecycle to reach a “fundable” size quickly. However, higher equity raises come with heightened growth expectations. Equity investors require attractive IRRs, which translates into pressure on management to deploy capital rapidly. This creates a structural bias toward rapid balance sheet expansion. This has led to situations where NBFCs publicly articulate aggressive growth targets-such as scaling to INR 500 crore in assets within six months-backed primarily by equity capital.
History shows that such premature scaling has repeatedly resulted in asset quality stress and significant portfolio delinquencies. Look around. In newer credit models and while lending to weaker borrower segments, sustainable outcomes require cautious, measured growth, strong underwriting feedback loops, and time to learn from portfolio behaviour. The current funding environment, however, makes such measured growth difficult: early-stage debt is scarce and expensive, while equity funding implicitly demands speed.
This raises a fundamental question: how can prudent, phased growth be achieved in new and riskier lending segments when access to borrowings is constrained in the early stages and equity capital pushes NBFCs toward premature scale?
Recently proposed draft changes in ECB guidelines – particularly the removal of interest rate caps- could help address this mismatch. These changes may enable a greater inflow of foreign capital with “mezzanine-like” characteristics, sitting between pure equity and senior debt. Such capital can partially substitute for equity, reduce immediate growth pressure, and allow NBFCs to scale more gradually while building robust credit models.
Will the Indian financial services industry now learn to adopt a changed mindset to look at mezzanine as a replacement of equity and not for debt?
The traditional Indian financing hierarchy is still very binary:
- Equity = permanent capital, growth risk, IRR expectations
- Debt = fixed obligations, ratings-driven, asset-backed
Mezzanine capital sits uncomfortably in between and is treated as “expensive debt. But in reality, especially for early- to mid-stage NBFCs, mezzanine behaves far more like equity than debt:
- It absorbs risk before senior lenders
- It allows time for seasoning of portfolios
- It reduces pressure for premature balance sheet expansion
- It aligns better with measured growth in new credit models
Without recognising this, the industry will keep repeating the same boom–bust cycle driven by equity-fuelled hypergrowth.
So, what do you think? Will relaxing ECB regulations lead to more robust NBFCs and better inclusive finance?
Avishek Gupta 