Two vehicle financiers publish results on the same afternoon. Both grew their loan books by about a quarter. Both lend to much the same borrowers, against much the same trucks, at rates within half a point of each other. One reports a net interest margin of 7.4% and the other 9.5%, and every explanation offered on the business channels that evening is about lending — better underwriting, a richer product mix, stronger recoveries. None of it is where the difference came from. The difference came from what the two companies pay for the money they lend, which is set by people who are not their customers, in a market they do not control, and which is disclosed in a note most equity investors skip on the way to the profit line.
A tea stall buys milk each morning and sells tea all day. Two stalls on the same road charge the same for a cup and sell the same number of cups. One buys milk on a yearly contract at a fixed rate; the other buys from whoever has stock that morning. When milk gets dear, the second stall’s day is ruined and the first stall does not notice for eleven months. Neither of them changed anything about the tea.
A finance company buys money and sells money. Its selling price is visible to everybody and gets all the attention. Its buying price is contracted separately, in several instruments, on several dates, at several tenors — and in most years it is the buying price, not the selling price, that moved.
The one structural fact that changes everything
A bank has a liability nobody else can have. Households and businesses keep money in current and savings accounts because a bank sits inside the payments system, and that money costs the bank very little or nothing at all. It is why a bank’s cost of funds can sit at four or five per cent while everybody else in the market pays eight. A non-banking financial company has no such thing. A small, separately authorised and long-shrinking category may accept public deposits; for practically every finance company you can buy on an exchange, every rupee it lends was first borrowed from somebody who was choosing between lending it here and lending it somewhere else.
What is actually in the borrowings note
| Instrument | Who lends it | What it does to the cost of funds |
|---|---|---|
| Term loans from banks | Banks, usually secured against a slice of the loan book | Mostly floating, linked to a published benchmark, so the rate resets on a schedule written into the sanction letter. It moves with policy whether or not the company has borrowed anything new |
| Non-convertible debentures | Mutual funds, insurers, pension money, and retail buyers in a public issue | Usually fixed until maturity, so it locks a rate in — which is protection in a rising cycle and a burden in a falling one |
| Commercial paper | Money-market funds and corporate treasuries, for weeks or months at a time | The cheapest line on the page and the one that has to be found again several times a year. It is priced off the rating and off how the market feels that week |
| External commercial borrowings | Overseas lenders and bond buyers, in foreign currency | The headline coupon looks low and is not the cost. The cost is the coupon plus the hedge — and where it is unhedged, the cost is unknown until the rupee has moved |
| Subordinated debt | Institutions willing to rank behind everybody else | The dearest borrowing on the page, taken because a portion of it counts towards regulatory capital. It buys growth capacity, not cheap money |
| Sold-down loan pools | Banks and investors buying portfolios outright or through a trust | Not borrowing at all in form, and funding in substance. It is the subject of the fourth lesson in this module |
The proportions across those rows are the borrowing mix, and they are disclosed — instrument by instrument in the borrowings note, and usually again as a chart in the investor presentation. The mix is a management decision with a genuine trade-off in it, and the trade-off is not the one most readers assume. Cheap and short is cheap because the lender is exposed for weeks. Dear and long is dear because the lender is exposed for years. A company that has skewed hard towards the cheap end has bought margin this year and sold itself an obligation to return to the market repeatedly — the mechanics of which the earlier module on borrowing short to fund long works through, and which are not repeated here.
Computing what the money cost, rather than reading what was claimed
- Finance cost
- The line in the profit and loss statement, taken gross
- Average borrowings
- Opening plus closing borrowings, divided by two. A finance company’s balance sheet does not carry one borrowings total or a separate current-maturities line the way a manufacturer’s does — it splits borrowings by instrument, so add the debt securities, the other borrowings, the deposits where there are any, and the subordinated liabilities together before averaging
- Why it differs from the presentation
- A company computing on month-end balances will publish a slightly different figure. Neither is wrong; use one method consistently and compare like with like across years
Example: Finance cost ₹1,180 crore against average borrowings of ₹14,300 crore gives 8.25%. That is what the whole stock of money cost last year. It is not what the next rupee costs.
The rating is not a comment on the company. It is a gate.
For a manufacturer, a credit rating is a useful outside opinion. For a finance company it is a piece of operating infrastructure, because a large part of the market that funds it is not permitted to buy below certain grades. Mutual fund schemes operate within mandates that reference rating categories; insurance and pension money is invested under investment rules that do the same. So a downgrade does two things at once, and the second is much worse than the first: the price of money goes up, and a set of buyers disappears entirely, regardless of price. A company that could raise ₹500 crore of paper in a morning discovers it cannot raise it at all, and the discovery happens on the day the maturing paper has to be repaid.
- Read the rationale, not the letter. Rating agencies publish a rationale for every action, free, and it is written for lenders — so it addresses liquidity, refinancing and covenant headroom in a directness that equity research rarely matches.
- Watch the outlook and the watch, not only the grade. A change from stable to negative is the agency saying the next move is more likely to be down than up, and funding costs frequently move on that alone.
- Note who else has been downgraded. Funding markets treat finance companies as a category. In the freeze that followed the default of a large infrastructure financing group in 2018, companies with no exposure to it and no asset-quality problem of their own found the commercial paper market shut to them for weeks. The mechanism is that the buyer’s question stops being about the borrower and becomes about the sector.
- Watch what the regulator does to the lenders’ lenders. How much capital a bank must hold against an exposure to a finance company is a policy variable, and it has been raised and eased more than once. When it changes, the price of bank funding moves for every finance company at the same time, for reasons entirely unconnected to any of them.
A finance company’s average cost of funds is 8.25%, and paper it raised during the year cost about 9.1%. Its loans are fixed-rate with three to four years to run. What does this most directly tell you about next year?
Aapne ₹50 lakh ka loan lekar dukaan kharidi aur teen saal ke agreement pe ₹40,000 mahina kiraye pe chadha di — saal ka ₹4.8 lakh, fix. Loan floating hai: is saal 8.25%, yaani byaaj ₹4.125 lakh. Bacha ₹67,500. Ab rate 9.1% ho gaya — byaaj ₹4.55 lakh, bacha sirf ₹25,000. Kiraya ek rupya nahi badla, kirayedaar ne kuch galat nahi kiya, aapne naya udhaar nahi liya. Finance company bilkul yahi hai: loan fixed rate pe diya hua hai, par jo paisa udhaar liya tha woh baar-baar naye rate pe badalna padta hai. Isliye borrowings note mein dekho ki is saal ka naya paisa kis rate pe aaya, aur agle saal kitna maturity pe aa raha hai.
- A bank’s cheapest funding is a relationship; a finance company’s is a price that is reset by professionals every quarter.
- The borrowing mix — bank loans, debentures, commercial paper, foreign borrowing, subordinated debt — decides how fast the cost of funds moves.
- Compute the cost of funds as finance cost divided by average borrowings, and compare it with what money raised this year cost.
- A fixed-rate loan book funded partly at floating rates compresses spread in a rising cycle without any decision being taken.
- A rating is a gate, not an opinion: a downgrade removes buyers who are not permitted to hold the paper at any price.
Mark it done to track your progress through the curriculum.