Credit Cycle and the NBFC Sector

In September 2018 a large AAA rated infrastructure lender and finance group, with about ₹91,000 crore of group debt, missed payments on its short term paper. Within weeks the whole non bank lending sector was short of money. Debt funds stopped rolling over commercial paper. Borrowing costs for NBFCs jumped. Several housing finance stocks lost more than half their value within months, and the slowdown spread to real estate, vehicles and consumer durables. All of it started with one institution that could not refinance three month paper.

Eight years later the same system looks very different. Bank gross NPAs are at a multi decade low. Credit is growing at its fastest pace in years. And on 7 October 2026 the RBI raised the repo rate for the first time since 2023. Good balance sheets, fast loan growth and rising rates: that combination is exactly where a credit cycle needs watching.

How India's credit cycle works

A credit cycle has four phases. They overlap and the lengths vary, but the order rarely changes.

• Expansion: rates are low or falling, banks and NBFCs lend freely, credit growth picks up, businesses invest, jobs and consumption grow, earnings improve and lenders' stocks do well.
• Peak: credit growth is high and standards slip. Riskier borrowers get loans. Collateral such as property and pledged shares looks safe because prices are up. Leverage builds quietly.
• Contraction: the RBI tightens, or a credit event hits. Lending slows, the weakest borrowers and lenders crack first, investment pulls back and earnings slow.
• Clean up: bad loans are recognised and provided for. Bank profits bottom out. Balance sheets heal and a new cycle can start.

Where is India now? Credit growth of 18.8% with gross NPAs at 1.8% and a central bank that has just started hiking reads like late expansion. That is not a forecast of trouble. It is a reason to watch the quality of new lending more closely than the headline profits.

The NBFC sector, India's shadow banking system

Non banking financial companies (NBFCs) lend but do not hold a banking licence. Most cannot take demand deposits, so they fund themselves with bank loans, bonds and commercial paper. India has thousands of them, from very large listed lenders to small microfinance institutions.

NBFCs serve the borrowers banks find harder to reach: used truck and tractor buyers, gold loan customers, microfinance groups, self employed home buyers and small businesses. That makes them central to rural and small business credit, and it makes their funding the weak point of the system.

The RBI regulates them under a scale based framework introduced in October 2021. NBFCs sit in a base, middle, upper or top layer depending on size and risk. The upper layer, named by the RBI each year, faces rules close to those for banks: tighter capital, governance and disclosure. The point of the design is simple. A lender that is large enough to cause a 2018 style crisis is supervised like a bank.

The 2018 NBFC crisis, a case study in credit cycle reversal

The lender that defaulted in 2018 borrowed short, through commercial paper and bonds, and lent long, to infrastructure projects that take years to pay back. When short term money stopped coming, it could not roll its debt. Two things made it a system event:

• The rating was wrong until it was not. The group carried the highest ratings until weeks before it defaulted. Ratings tell you about the past. Funding markets tell you about today.
• Contagion ran through debt funds. Funds that held its paper took losses and faced redemptions. To protect themselves they stopped buying commercial paper from other NBFCs too. Lenders with nothing to do with infrastructure suddenly could not refinance.

In June 2019 a large housing finance company followed: short term funding, long dated home loans and governance problems, ending in default and, in November 2019, the RBI superseding its board. Two failures in nine months taught the same lesson. In India's credit system, the most persistent risk is an asset liability mismatch at a lender that depends on market funding.

1. Sep 2018A large AAA rated infrastructure lender defaults

   Short term paper cannot be rolled. The government supersedes its board in October.

2. Late 2018Debt funds pull back from NBFC paper

   Funding costs jump across the sector; the RBI adds liquidity.

3. Jun 2019A large housing finance company defaults

   In November 2019 the RBI supersedes its board and refers it to insolvency.

4. Oct 2021Scale based regulation for NBFCs

   Base, middle, upper and top layers; bank like rules for the largest.

5. Nov 2023Risk weights raised 25 points

   On unsecured consumer credit and on bank loans to NBFCs.

6. Feb 2025NBFC risk weights restored

   Effective 1 April 2025.

7. Oct 2026Repo raised to 5.50%

   With bank GNPA at 1.8% and credit growing 18.8%.

Worked example, an NBFC balance sheet under a funding shock

Take a hypothetical mid sized NBFC with a ₹10,000 crore loan book. Equity is ₹2,000 crore. Borrowing is ₹8,000 crore: ₹5,000 crore of bank loans and bonds of three to five years, and ₹3,000 crore of commercial paper that matures every three months. Its loans run three years on average, so roughly ₹830 crore of principal comes back each quarter.

• Normal times: the ₹3,000 crore of paper is rolled every quarter at, say, 7.5%. Nobody notices.
• Rates rise: commercial paper reprices to 10%. The extra cost is 2.5% on ₹3,000 crore, ₹75 crore a year. On a book earning 14% and costing 8.5%, the spread is about ₹550 crore a year, so profit falls but the company survives.
• The market shuts: nobody will roll the paper. The company has to find ₹3,000 crore in 90 days while only about ₹830 crore of loans come back. The gap is roughly ₹2,170 crore. Equity of ₹2,000 crore cannot fill it, because equity is already lent out. It has to stop lending, sell loans at a discount or default.

NPA cycle, how bad loans move through the system

The non performing asset (NPA) cycle is the rise and fall of bad loans. India's last full cycle ran roughly from 2010 to 2022:

• Around 2008 to 2012: banks lent heavily to infrastructure, power, steel and real estate. Project costs overran and promoters took on too much debt.
• 2012 to 2015: projects stalled. Loans were restructured again and again, which pushed the problem forward. Bad loans grew but stayed partly hidden.
• 2015 to 2018: the RBI's Asset Quality Review forced banks to recognise bad loans. The gross NPA ratio peaked at about 11.2% in March 2018. Public sector banks needed fresh capital.
• 2018 to 2022: the Insolvency and Bankruptcy Code of 2016 started resolving large cases. Balance sheets were cleaned and the ratio fell to 5.9% by March 2022, then kept falling to 1.8% by March 2026.

Credit growth as a leading economic indicator

The RBI publishes bank credit data every fortnight and sector wise deployment every month. Year on year credit growth is one of the best live reads on economic momentum. Rough bands:

• Above 15%: strong expansion. Good for lenders and cyclicals, and the point at which the RBI starts asking about loan quality.
• 10% to 15%: steady growth.
• Below 8%: slowdown. Watch guidance from consumer and capital goods companies.
• A sharp fall from a high level: often the first sign of stress, before it shows up in NPAs.

In the 12 months to August 2026 non food credit growth almost doubled, from 10.2% to 18.8%, with industry credit up 18.2%. Some of that reflects working capital needs when crude and import costs rise. Some is genuine investment. The split matters, and the monthly sector data shows it.

Regulation moves this cycle too. In November 2023 the RBI raised risk weights on unsecured consumer credit and on bank loans to NBFCs by 25 percentage points, making that lending more expensive in capital terms. Bank lending to NBFCs slowed sharply. In February 2025 the RBI restored the NBFC risk weights from 1 April 2025. When the regulator leans against a segment, credit growth in that segment slows within a few quarters.

Reading lender stocks through the cycle

NSE's financial indices let you see the cycle in prices. In the 12 months to 9 October 2026, a year of record credit growth and a late turn to tightening, Nifty PSU Bank rose 7.4% on a P/E of 7.3. Nifty Private Bank fell 1.1%. Nifty Bank fell 1.7% on a P/E of 13.1. Nifty Financial Services, which adds NBFCs, insurers and market intermediaries, fell 6.6%. The Nifty 50 fell 10.6%.

Lenders held up better than the index because their earnings grew. The low P/Es are the market's way of saying it does not fully trust the cycle to last. When rates rise, lenders that fund themselves with deposits usually reprice loans faster than deposits for a while. Lenders that fund themselves in the bond and commercial paper market feel the higher cost sooner. That difference is the first thing to check when the RBI turns.

Common mistakes

Questions readers ask

Rules and figures in this module were last verified on 12 Oct 2026. Tax and regulatory rules change; check the source before acting.