What Are the Risks Associated With Investing in NBFC Bonds?

NBFC bonds are fixed-income instruments issued by non-banking financial companies to raise capital, and they typically offer better returns than bank deposits or bank bonds. This higher yield compensates for the slightly higher risks associated with NBFC bonds.

Apart from a higher credit risk, NBFC bonds also carry interest rate risks, liquidity risks, inflation risks, regulatory risks, and reinvestment risks. In this article, we discuss each of these key risks associated with NBFC bonds in detail and also outline practical ways of managing them. 

Risks Associated With NBFC Bonds

If you’re thinking of adding NBFC bonds to your fixed income portfolio, you should be aware of the following NBFC bonds risk factors:

1. Credit Risk of NBFC Bonds

The credit risk associated with NBFC bonds refers to the possibility that the issuer may fail to pay interest or repay the principal on time. NBFCs often lend to borrowers who may not qualify for bank loans, which increases repayment risk during economic slowdowns.

Here’s what you need to know about the credit risk associated with NBFC bonds:

• The credit risk of NBFC bonds depends on the NBFC’s financial health and credit rating
• AAA or AA-rated NBFC bonds generally carry lower default risk
• Lower-rated NBFC bonds have higher vulnerability to delayed or missed payments
• NBFC bonds also carry the risk of ratings downgrade due to defaults by the issuer

2. Interest Rate Risk

NBFC bond risk factors also include interest rate risks. Just like all bond investments, NBFC bonds are also affected by changes in the prevailing interest rates in the market. 

• Bond prices move inversely to interest rates
• When market interest rates rise, existing NBFC bonds with fixed coupons become less attractive
• As a result, the market value of these NBFC bonds tends to fall

But do note that this risk associated with NBFC bonds mainly affects investors who may need to sell before maturity because bond prices fluctuate in the market when interest rates change. 

3. Liquidity Risk

Liquidity risk is an important part of NBFC bond risk factors. Even though many NBFC bonds are listed on stock exchanges, trading volumes in the secondary market can be limited.

This means:

• Finding buyers at a fair price may be difficult when you want to exit early
• Limited demand can lead to price discounts during early sale
• Possible delays in redeeming your investment, especially at times when you need funds urgently

Moreover, this NBFC bond risk factor may be more pronounced for certain types of bonds like lower-rated NBFC bonds and unlisted bonds.

4. Regulatory and Sector Risk

Regulatory and sector-related changes form an important part of NBFC bond risk factors. NBFCs operate under guidelines issued by the Reserve Bank of India, and any change in these rules can affect their operations and cash flows.

For instance:

• Changes in capital adequacy or provisioning norms may impact NBFC profitability
• Tighter regulations can increase funding pressure on NBFCs
• Many NBFCs have exposure to cyclical sectors like infrastructure or real estate
• Sector-specific stress can increase overall NBFC bond risks

All these factors can influence the repayment ability of NBFCs, making them an important part of the risks associated with NBFC bonds.

5. Inflation Risk

Inflation risk is a common risk factor in all fixed-income investments. Therefore, this NBFC bond risk factor is pertinent for bonds that offer fixed interest or coupon payments throughout the investment tenure.

Here’s what you should know about the inflation risk associated with NBFC bonds: 

• Rising inflation reduces the purchasing power of fixed bond returns
• Longer-tenure NBFC bonds are more exposed to this NBFC bond risk because the impact of inflation becomes more pronounced over extended periods
• Fixed coupons do not adjust automatically with inflation levels

6. Call Risk and Reinvestment Risk

Call risk arises when an NBFC bond includes a call option that allows the issuer to redeem the bond before maturity. Usually, issuers exercise this option when interest rates fall to refinance at a cheaper rate.

This can lead to:

• Reinvestment risk where you have to reinvest the proceeds at a lower interest rate
• Lower than estimated yield, especially in a falling interest rate environment

When it comes to NBFC bond risk factors, reinvestment risks are not limited to callable bonds. They may also arise if the bond matures when interest rates are falling. This can also force you to invest the principal at a lower rate than the original bond rate.

How to Manage Risks Associated With NBFC Bonds

Now that you know all about the risks associated with NBFC bonds, here’s how you may be able to manage them:

1. Focus on Credit Ratings

Credit ratings provide a structured assessment of an issuer’s repayment ability and creditworthiness. These ratings are assigned by credit rating agencies such as CRISIL, ICRA, and CARE to indicate the likelihood of the issuer defaulting on its repayment obligations.

Here’s how you may manage the credit risk associated with NBFC bonds:

• Pay attention to the credit rating of the issuer, rather than simply focusing on yield
• Prefer bonds issued by higher-rated (AAA or AA) NBFCs
• Treat lower-rated bonds as higher risk, even if yields appear attractive

2. Try to Avoid Long Maturity Periods

The interest rate risk becomes more pronounced for long-term NBFC bonds. Therefore, you can manage this risk by:

• Choosing shorter-tenure NBFC bonds (1-2 years) to reduce sensitivity to interest rate movements
• Holding bonds until maturity to avoid losses from interim price fluctuations
• Spreading investments across different maturity periods to reduce timing risk

3. Planning for Liquidity Needs

The liquidity risk associated with NBFC bonds can be managed by:

• Choosing NBFC bonds from issuers with better secondary market demand
• Selecting listed, high-rated bonds which may be easier to sell in the secondary market
• Creating a liquid contingency fund that can cover emergency expenses

4. Understanding Inflation Protection

There are greater chances of inflation eroding your real returns when you hold the bond for a longer duration. But you may be able to manage inflation risks associated with NBFC bonds by:

• Avoiding to concentrate only in long-term fixed-rate NBFC bonds
• Reviewing bond income periodically against rising living costs
• Balancing fixed-income investments with options that offer higher yields over time

Some Other Ways to Manage NBFC Bond Risk Factors

You may also add these checks to better manage the risks associated with NBFC bonds:

• Review Issuer Financials: Look beyond credit ratings and assess balance sheets, leverage, and funding sources to identify hidden NBFC bond risk factors early. 
• Be Cautious With High Returns: NBFC bonds offering unusually high yields may often signal higher credit risk or liquidity risk.  
• Diversify Across Issuers and Sectors: You may consider spreading investments across multiple NBFC issuers and sectors to reduce concentration risk and manage overall NBFC bond risks better.
• Track Credit Rating Changes Regularly: Credit rating agencies may upgrade or downgrade NBFC bonds based on financial performance, asset quality, or market conditions. Monitoring ratings even after investing helps you reassess risk and take timely action if the issuer’s profile weakens.

Final Thoughts: Know the Risks Before Investing in NBFC Bonds

NBFC bonds can be attractive for higher returns, but they are not risk-free. Some of the key risks associated with NBFC bonds include:

• Credit risk
• Interest rate risk
• Liquidity risk
• Inflation risk
• Reinvestment and call risk

Understanding NBFC bond risks helps you decide whether these instruments suit your risk appetite and income expectations before investing.

Ready to invest in NBFC bonds? Visit the Goldenpi platform where you can review the  list of NBFC bonds and check credit ratings, issuer details, tenure, and payout structures clearly.  Once you’ve picked one, you can start investing in just a few minutes!

Risks Associated with NBFC Bonds FAQs

Is it safe to invest in NBFC bonds?

The safety of NBFC bonds depends on the credit ratings of the NBFC. Bonds from higher-rated (such as AAA or AA) NBFCs generally carry lower default risk. 

However, lower-rated NBFC bonds may carry a higher default risk. Therefore, it is important to check the credit rating of the NBFC to gauge safety before investing in its bonds. 

What are the risks of investing in NBFC bonds?

Key NBFC bond risks include credit risk, interest rate risk, liquidity risk, regulatory changes, inflation risk, and reinvestment risk.

How can I manage the credit risk of NBFC bonds?

You can reduce the credit risk associated with NBFC bonds by focusing on high-rated bonds. High ratings like AAA and AA typically connote highest creditworthiness and low risk of default. 

Disclaimer:

This information is for general information purposes only. GoldenPi makes no guarantee on the accuracy of the data provided here; the information displayed is subject to change and is provided on an as-is basis. Nothing contained herein is intended to or shall be deemed to be investment advice, implied or otherwise. Investments in debt securities/ municipal debt securities/ securitised debt instruments are subject to risks including delay and/ or default in payment. Read all the offer related documents carefully.

Bonds or non-convertible debentures (NCDs) are regulated by the Securities and Exchange Board of India and other government authorities. GoldenPi Securities Private Limited is a registered debt broker and acts as a distributor and not as a manufacturer of the product.