About Northern Arc Capital Limited

Northern Arc Capital is a diversified financial services platform set up primarily with the mission of catering to the diverse retail credit requirements of the under-served households and businesses in India. Over the last 15 years, their approach has been to create a differentiated and comprehensive play on the retail credit ecosystem in India spread across sectors. Since 2009, when they entered the financial inclusion space, they have facilitated financing of over ₹1.73 trillion that has impacted over 101.82 million lives across India, as of March 31, 2024. According to the Report, they are one of the leading players amongst India’s diversified NBFCs in terms of Assets under Management (“AUM”) as of March 31, 2024, with a business model diversified across offerings, sectors, products, geographies and borrower categories. Further, they have one of the lowest industry-wide credit costs amongst diversified NBFCs in India, as of March 31, 2024. 

They have developed domain expertise in enabling credit across their focused sectors in India, namely, micro, small and medium enterprises (“MSMEs”) financing, microfinance (“MFI”), consumer finance, vehicle finance, affordable housing finance and agricultural finance. They have been operating in the MSME, MFI and consumer finance sectors for over 14 years, 15 years and nine years, respectively. 

They have built an efficient and scalable business model, supported by their proprietary end-to-end integrated technology product suite customised to multiple sectors. Their in-house technology stack consists of: (i) Nimbus, a curated debt platform that enables end-to-end processing of debt transactions; (ii) nPOS, a co-lending and co-origination technology solution based on application programming interfaces (“API”); (iii) Nu Score, a customised machine learning based analytical module designed to assist our Originator Partners in the loan underwriting process; and (iv) AltiFi, an alternative retail debt investment platform.

Credit penetration in India
The retail credit (includes Housing finance, Vehicle Financing, Gold Loans, Education Loans, Consumer Durables, Personal loans, Credit cards and Microfinance) in India stood at Rs. 75.2 trillion, as of Fiscal 2024 and has rapidly grown at a CAGR of 16.0% during Fiscals 2020 and 2024. Retail credit growth in Fiscal 2020 was around approximately 12.1% which came down to approximately 9.6% in Fiscal 2021. However, post-pandemic, retail credit growth revived back to reach approximately 13.5% in Fiscal 2022. In Fiscal 2023, retail credit has grown at ~22.3% year on year basis. The Indian retail credit market has grown at a strong pace over the last few years and is expected to further grow at CAGR of 17-18% between Fiscals 2024 and 2026 to reach Rs. 100.9 trillion by Fiscal 2026. The moderation of growth of retail credit is on account of normalisation in unsecured segment which had witnessed exuberant growth in the past and impact of RBI’s risk weight circular. Moreover, the increasing demand and positive sentiments in the Indian retail credit market, presents an opportunity for both banks and NBFCs to broaden their investor base.

Personal Loan and Service segment to drive credit growth in Fiscal 2025
Industrial credit accounted for nearly a third of the overall banking credit mix in Fiscal 2019. 

CRISIL MI&A estimates that agricultural credit grew in Fiscal 2024 due to higher priority sector lending (“PSL”) targets, expected higher food-grain production, increase in commodity prices and increase in agriculture credit target. Industrial credit grew in Fiscal 2024 supported by healthy growth in segments like basic metal and metal products, chemical and chem products and government’s continued focus on production linked incentive scheme. Services segment grew in Fiscal 2024 on back of healthy credit demand from Non-Banking Financial Companies (“NBFCs”). Personal Loans segment grew in Fiscal 2024 driven by sharp rise in demand in unsecured loans, demand in housing segment and pent-up demand in vehicle loans segment.

Going forward, CRISIL MI&A expects personal loans and services segment to drive credit growth in Fiscal 2025. Personal Loans segment is expected to show strong growth in Fiscal 2025 on back of credit demand from consumer durables, gold and other personal loan segment.

Digital payments have witnessed substantial growth
The share of different channels in domestic money transfer has changed significantly over the past five years. Banks, for example, are witnessing a change in customer behaviour with fewer customers visiting bank branches for transactions. This change in behaviour was led by demonetisation when cash transactions slowed down, many new accounts were opened, and digital banking witnessed a surge in use and continued its growth trajectory. Post-COVID-19, with consumers preferring to transact digitally rather than engage in physical exchange of any paper or face-to-face contact, digital transactions have received another shot in the arm. 

Between Fiscals 2018 and 2024, the volume of digital payments transactions has increased from ₹14.6 billion to ₹164.4 billion, causing its share in overall payment transactions to increase from 59% in Fiscal 2018 to 97% in Fiscal 2024. During the same period, value of digital transactions has increased from ₹1,371 trillion in Fiscal 2018 to ₹2,428 trillion in Fiscal 2024.

Consumers are increasingly finding transacting through mobile convenient. CRISIL MI&A expects the share of mobile banking and prepaid payment instruments to increase dramatically over the coming years. In addition, CRISIL MI&A expects improved data connectivity, low digital payment penetration and proactive government measures to drive digitalisation in the country, transforming it into a cashless economy. 

The value of digital transactions as a proportion of private consumption expenditure in between Fiscal 2016 and Fiscal 2023 also rose from 1,132% to 1,271%, which shows that the usage of digital transactions for consumption has been on the rise over the past few years.

NBFC credit to grow faster than systemic credit between Fiscals 2024 and 2026
CRISIL MI&A projects NBFC credit to grow at 16%-18% between Fiscal 2024 and Fiscal 2026. The credit growth will be driven by the retail vertical, including housing, auto, and microfinance segments. Rapid revival in the economy is expected to drive consumer demand in Fiscal 2025, leading to healthy growth of NBFCs. Moreover, organic consolidation is underway with larger NBFCs gaining share with some of the merger and acquisition in the NBFC space such as Ambit Finvest’s acquisition of SME Corner and merger of Incred and KKR India. Further growth of the NBFC industry will be driven mainly by large and medium size players with strong parentage who have funding advantage and capability to invest and expand into newer geographies.

Retail segment to support NBFCs overall credit growth
The NBFC sector has, over the years, evolved considerably in terms of size, operations, technological sophistication, and entry into newer areas of financial services and products. The number of NBFCs as well as the size of the sector have grown significantly, with a number of players with heterogeneous business models starting operations. The increasing penetration of neo-banking, digital authentication, and mobile phone usage as well as mobile internet has resulted in the modularization of financial services, particularly credit. Overall NBFC credit during Fiscals 2020 to 2024, witnessed a CAGR of ~12% which was majorly led by retail segment which accounts for ~48% of overall NBFC credit and witnessed a CAGR of ~15%, while NBFC non-retail credit witnessed a growth of ~9% during the fiscals. 

Going forward, growth in the NBFC retail segment is expected at 16-18% CAGR between Fiscals 2024-2026 which will support overall NBFC credit growth, with continued focus on the retail segment and multiple players announcing plans to reduce wholesale exposure. The retail segment’s market share is expected to rise further to 48% by end of Fiscal 2025 and remain around 48.5% in Fiscal 2026.

Impact of digitization on retail credit
Digital lending products such as instant loans or online personal loans have completely revolutionised retail credit due to great convenience that it offers to the customers. The underwriting process, while essential for assessing borrowers, can sometimes be time-consuming and reliant on subjective elements. Thus, there is room for improvement in leveraging all available data efficiently. Organizations may find opportunities to streamline the process, making it more agile and resource effective. Lenders are increasingly using their web platforms and creating apps to register, score, approve and disburse loans to their customers. For lenders, digitization has enabled them to make informed decision making through business insight generation and data visualization. Moreover, it has improved lead generation for lenders with faster onboarding of customers, comprehensive loan servicing, and fraud detection. For customers, it has become easier to gather information about different lenders with the help of digitization and compare them. Further, online loan application has made it convenient for borrowers to fill loan applications from remote locations, calculate EMIs, check for eligibility of loan amount and provide all documents digitally which enhances customer experience throughout the process and help them make an informed decision.

Furthermore, the India Stack, a set of APIs and tools that enable the building of digital platforms for various services, has been a game-changer in the retail credit sector. The India Stack includes Aadhaar (for identity verification), e-KYC (for paperless Know Your Customer processes), eSign (for digitally signing documents), and the Unified Payments Interface (UPI) for seamless and instant fund transfers. All of these components have been seamlessly integrated into the digital lending ecosystem, making it easier for lenders to streamline their operations and offer a seamless experience to borrowers. Looking ahead, the digitization of retail credit in India is expected to continue evolving.

Banks continue to gain share in borrowing mix of NBFCs
In Fiscal 2024, NBFCs’ borrowings from banks witnessed high growth resulting in an increase in share to 38% of total funding up from 29% at the end of Fiscal 2022. Share of bank’s lending to NBFCs have almost doubled during last 10 years. Going forward, CRISIL MI&A believes that funding access would gradually improve for NBFCs who are able to demonstrate strong performance and strong parentage. However, reliance on bank funding and funding from other NBFCs and small finance banks is expected to remain high in Fiscal 2025.

Going forward, bank funding to NBFCs is expected to continue to remain healthy, given the higher liquidity with banks. This will result in banks gaining further share in the borrowing mix across all NBFCs.

Growth in the banks’ credit exposure to NBFCs grew at 14.28% from March 2023 to December 2023. The share of NBFCs in the overall credit exposure is at 9.6% as of December 2023. 

Asset quality improved on account of efficiency in collection process and improvement in economic activity in Fiscal 2023 

Asset quality for NBFCs is influenced by various factors such as economic cycle, target customer segment, geographical exposure, and local events. Within the NBFC universe itself, it is observed that various asset classes tend to exhibit heterogeneous behaviour. For example, the asset quality in small business loans and personal loans tends to be highly correlated with the macroeconomic environment. On the other hand, microfinance loans have shown lower historic correlation with macroeconomic cycles. This is because asset quality is more influenced by local factors, events that have wide ranging repercussions such as demonetisation and COVID-19 and relative leverage levels amongst borrowers. 

Prior to Fiscal 2018, smaller NBFCs were aggressively expanding in terms of both market penetration and lending across asset classes, which led to rising asset quality concerns. The proportion of standard assets declined, as slippages to substandard category increased. After the NBFC crisis in Fiscal 2019, smaller NBFCs slowed down their lending activity and focused on improving their asset quality and shifting to retail segments that are less risky. In Fiscal 2020, doubtful assets for NBFCs registered a marginal uptick due to funding challenges and slower credit growth. However, efforts were made by NBFCs to clean up their balance sheets, as reflected in their write off and recovery ratios, which caused the NNPA (Net Non-Performing Asset) to remain stable, and the PCR (Provisioning Coverage Ratio) to improve. 

In Fiscal 2021, the proportion of doubtful and loss assets increased, largely driven by infrastructure and wholesale finance. In addition to funding challenges faced by the sector along with slower credit growth, COVID-19 escalated asset quality deterioration further owing to restricted movement, which affected collections. Moratorium and restructuring schemes announced by the Government came as an interim relief for the sector and delayed the asset quality concerns for some time. However, with the NPA standstill provision lifted in August 2020, gross NPAs (“GNPAs”) in segments such as auto, microfinance and MSME spiked as of March 2021. 

Further, the second wave of COVID-19 adversely affected the fragile recovery witnessed in the fourth quarter of Fiscal 2021 and affected collection efficiencies across asset classes in the first quarter of Fiscal 2022. However, the impact was not as severe as in the first wave, and players across segments reported improvement in GNPAs from the second quarter. 

In November 2021, the RBI gave a clarification to the ‘Prudential norms on Income Recognition, Asset classification and Provisioning pertaining to Advances’, which requires the NBFCs to recognise NPAs on a daily due basis as part of their day-end process which is expected to lead to higher GNPA. Typically, the NBFCs ramp up their collection activity between due-date and month-end, leading to lower dues by the end of month. This flexibility will no longer be available to the NBFCs which could cause some proportion of loans in the 60–90-day period category to slip into >90 days period category. In addition to the end of the day recognition, the RBI has also clarified that upgradation of an account from NPA to standard category can only be done after all over-dues are cleared (principal along with interest), resulting in a borrower slipping into the NPA category to remain in the same category for longer time compared to the past. Hence, NBFC GNPAs increased in third quarter of Fiscal 2022 due to adherence to the said RBI clarifications. But with NBFCs bolstering their collection efforts and processes, and improvement in economic activity, as of Fiscal 2023, asset quality of NBFCs further improved on account of strong economic activity and improved collection efficiency and in fiscal 2024, collection efficiency is expected to have hold up well, resulting in further easing of gross non-performing assets (GNPAs). CRISIL MI&A estimates GNPAs for NBFCs to have reduced significantly at the end of Fiscal 2024.

Rising penetration to support continued growth of the industry
With economic revival and unmet demand in rural regions, CRISIL MI&A expects the overall MFI portfolio size to grow at CAGR of 16-18% between Fiscals 2024 and 2027. CRISIL MI&A expects NBFC-MFI industry to log 23-25% CAGR between Fiscals 2024 and 2027. Key drivers for the superior growth outlook include increasing penetration into the hinterland and expansion into newer states, faster growth in the rural segment, increase in average ticket size and higher usage of support systems such as credit bureaus. The presence of self-regulatory organisations, such as MFIN (“Microfinance Institutions Network”) and Sa-Dhan, is also expected to support the sustainable growth of the industry going forward. Moreover, household credit is a huge untapped market for the MFI players. The country has seen household credit penetration via MFI loans rising, but it is still on the lower side.

NBFC MFI Industry to grow at a faster rate than overall MFI Industry
The portfolio outstanding of the NBFC-MFIs grew at a healthy CAGR of 23% between Fiscals 2018 and 2024 to Rs 1,709 billion. NBFCs, SFBs and NBFC-MFIs registered highest growth at 37%, 28% and 24% respectively in Fiscal 2024. Going ahead, CRISIL MI&A expects the NBFC-MFIs to continue to outplace other MFI lenders amid improving asset quality and continued traction in economic activity. Complementing the tailwinds will be rising profitability supported by higher net interest margins. The confluence of these factors augurs well for the credit profiles of NBFC MFI, allowing them to grow faster. The NBFC-MFIs are expected to gain market share in the medium term with a healthy double-digit CAGR of 23-25% between Fiscals 2024 and 2027.

Small Business Loans
In this section, CRISIL have classified all loans with ticket size lower than ₹1 crore extended to MSMEs, irrespective of the turnover of the entity, as small business loans. CRISIL MI&A estimates outstanding small business loans given out by banks and NBFCs to be around ₹13.1 trillion as of March 2024. Small business loans grew at a fast pace, registering a CAGR of 15% over Fiscal 2019 and 2024. 

Over the years, more data availability and government initiatives like GST has led to increasing focus of lenders, especially the NBFCs, on the underserved segment of MSME customers as lending to this segment has become easier compared to the past. 

Growth in small business loans was supported by increase in disbursements in the non-loan against property (“LAP”) (unsecured and secured) segment for NBFCs due to rapid industrialisation, driven by loans to the micro segment. With economic activity reviving and cash flows improving, NBFCs increased their funding in the unsecured segment while restricting lending in the LAP segment owing to the asset quality stress of the previous years. Growth was further led by improved underwriting, increasing funding to the unsecured portfolio.

Mid corporate loans
We have defined mid-corporate loans as loans with a ticket size of between ₹5-30 crore. The aggregate value of such loans given out by NBFCs is estimated at around ₹1.37 trillion as of March 2023. Between Fiscals 2017 and 2023, NBFCs credit to the mid-corporate segment increased at a strong approximately 18% CAGR.

Personal Loans
CRISIL MI&A estimates the segment to grow by 18-20% in Fiscal 2024 benefitting from a healthy credit demand. However, systemic hardening of interest rates, inflation and other macro factors could present challenges to growth in the near term. GNPA levels are estimated to normalize in Fiscal 2024 inching closer to pre-pandemic levels, led by a continued recovery in collection efficiency and high write-offs, driven by healthy capital buffers, along with healthy growth in the loan book. A marginal uptick is expected in fiscal 2025, as the loan book undergoes some seasoning after a period of supernormal loan-book growth in previous fiscals. 

The outstanding credit for NBFCs stood at ₹2.6 trillion in Fiscal 2024 after posting strong growth of 48% in Fiscal 2023 and 21% in Fiscal 2024. It is further projected to grow to approximately ₹3.2 trillion in Fiscal 2025 with a growth rate of 19-20%.

Gold loans
The gold loan sector is still largely catered by unorganized players with potential for new entrants to enter the market and create space. Gold loans are typically small ticket, short duration, convenient and instant credit, and are typical sourced and serviced through a physical branch infrastructure. Moreover, the gold loan product and customer segment are adjacent to the small ticket financing segment – for both consumers and small businesses alike.

Two-Wheeler Loans
Two-wheeler sales witnessed substantial growth of 14% in Fiscal 2024 from Fiscal 2023 owing to increase in scooter sales as urban income sentiments improved and EV penetration increased. Under two-wheeler segment, scooters grew at a faster pace than motorcycles as urban sentiments recovered faster. Moreover, electric two-wheeler also witnessed record high sales in Fiscal 2024. However, overall sales volume is still below the pre-pandemic levels due to significant price hikes witnessed by two-wheeler segment in last four Fiscals thereby affecting consumer sentiments.

Housing finance focused on low- and middle-income housing segment
In this section, housing loans with ticket size lesser than ₹7.5 million in metro regions and ₹5 million in non-metro regions have been included. Loans offered below these thresholds are referred to as housing loans focused on low- and middle income housing segment. 

The low- and middle-income segment focused housing finance market clocked a healthy CAGR (growth in loan outstanding) of approximately 13% over Fiscals 2018-2024 on account of a rise in disposable income, healthy demand and a greater number of players entering the segment. As of March 2024, outstanding loans to this segment approximated estimated at around ₹33.4 trillion. 

CRISIL MI&A estimates home loans outstanding (banks and non-banks) focused on low- and middle-income housing segment to grow with CAGR of 14-16% between Fiscal 2024 to Fiscal 2027. With investment demand being relatively low, demand will be largely propelled by buyers in the affordable and mid-income housing segment who are looking at a home purchase for own use.

Agriculture value chain Finance
₹16.5 trillion in Fiscal 2022 to ₹18 trillion in Fiscal 2023 and estimated credit growth in agri-ancillary activities like food processing, setting up agri-clinics and agri-business centres. While growth remained moderate in Fiscal 2023, it is estimated to have grown year on year at 9% in Fiscal 2024. This can be attributed to agri-credit target for Fiscal 2024 which was set to ₹20 trillion with major focus on agri-allied sectors. The highest share of institutional credit (towards agriculture sector) goes towards pre-harvest activities, followed by infrastructure financing as of Fiscal 2024. Increase in agriculture production capacity, rising demand for food and processed goods, and entry of organized players in the market are expected to push credit demand for post-harvest financing as well. 

NBFCs are mainly present in the farm mechanisation and infrastructure finance. Post-harvest financing, which includes warehouse receipt finance as well as loans for food and agro processing loans, is another space where NBFCs are increasing their presence continuously and has strong growth potential in the coming years. 

CRISIL MI&A estimates that the commodities (except for perishables like fruits and vegetables) are held by various participants of the agriculture value chain for an average period of 6-9 months in a year. However, due to the seasonality factor, the peak funding requirement arises during the harvest time (from September to February), which CRISIL MI&A estimates to be 1.5 times of the average funding requirement in a year availed by all participants in the agriculture value chain.

NORTHERN ARC CAPITAL LIMITED COMPETITIVE STRENGTHS
1. Large addressable and underpenetrated market with strong sectoral expertise
2. Large ecosystem of partners and data and technology platform creating strong network effects
3. Proprietary technology product suite transforming the debt market ecosystem
4. Robust risk management based on domain expertise, proprietary risk models and data repository driving asset quality
5. Diversified sources of funding for their own deployment and proactive liquidity management
6. Professional management team supported by an experienced Board and marquee investors driving high standards of governance
7. Strong ESG framework integrated into the business model with focus on creating sustainable impact and climate-smart lending

NORTHERN ARC CAPITAL LIMITED STRATEGIES
1. Enhance their ecosystem by growing and deepening relationships with their partners, while leveraging and scaling up their technology products
2. Expand to adjacent sectors such as climate lending and gold loans, and enhance our ESG risk management systems
3. Expand their Fund Management channel
4. Continue to scale their Direct to Customer Lending channel to enhance risk adjusted returns
5. Focus on credit quality to manage credit cost efficiently
6. Continue to diversify our source of funds and widen their lender base to scale their borrowing requirements while lowering costs
7. Expansion through inorganic growth

NORTHERN ARC CAPITAL LIMITED RISK FACTORS & CONCERNS
1. A significant portion of their investments are in credit facilities and debt instruments that are unsecured, and/or subordinated to other creditors.
2. The locations in which they operate could experience natural disasters.
3. The business operates through various channels, which inherently carry certain risks that could adversely affect their business, results of operations, cash flows and financial condition.
4. They depend on the accuracy and completeness of information about borrowers for certain key elements of their credit assessment and risk management process.
5. They may be unable to recover the full amounts due to them through their collections mechanism.
6. They are highly dependent on their relationships with their Originator Partners, Retail Lending Partners and Investor Partners for their operations.
7. They utilize the services of certain third parties for their support functions.
8. They may be required to increase their capital adequacy ratio.
9. Certain of their Subsidiaries have incurred losses in the past.
10. They offer products that are inherently complex and all possible risks are difficult to predict and mitigate.