Bajaj Finance's Cost of Funds Set to Decline: A Strategic Shift in India's Financial Sector?

Bajaj Finance, one of India’s leading non-banking financial companies (NBFCs), has signaled optimism about its funding costs, with management projecting a decline to a range of 7.75%-7.85% in the coming quarters. This shift comes amid a backdrop of rising deposit costs and margin pressures, as seen in its recent financial performance. Let’s dissect the drivers behind this outlook and its implications for investors.

Current Context: Cost of Funds at 7.94%

In its Q1 FY2025 results (April-June 2024), Bajaj Finance reported a cost of funds of 7.94%, up 8 basis points (bps) from the previous quarter. This increase contributed to a 23 bps compression in its net interest margin (NIM), with 13 bps of the decline directly tied to higher funding costs. While deposits grew 26% year-on-year to ₹62,774 crore—accounting for 20% of total borrowings—the expansion weighed on the cost of funds due to competitive pricing in the fixed deposit (FD) market.

Drivers of the Expected Decline

1. Deposit Mix Optimization

Bajaj Finance’s strategy to attract deposits at lower rates is central to its outlook. The company’s FD offerings, particularly for 24–35 month tenures, currently yield 7.80% at maturity—a rate within the projected 7.75%-7.85% range. By shifting its deposit portfolio toward longer-term instruments with lower marginal costs, Bajaj can reduce reliance on costlier short-term borrowings. For instance, its systematic deposit plans (SDPs) and competitive senior citizen rates (offering up to 8.20%) may help stabilize funding costs while attracting patient capital.

2. Asset Growth and Margin Management

Despite NIM compression, Bajaj Finance’s net interest income (NII) surged 25% YoY to ₹8,365 crore in Q1 FY2025, driven by a 31% YoY jump in assets under management (AUM) to ₹3.54 trillion. This scale advantage allows the company to negotiate better terms on funding. As loans and deposits grow, economies of scale could lower the average cost of funds.

3. Market Conditions and RBI Policy

India’s residential inflation has moderated to around 5% in recent months, creating a favorable environment for stable or declining interest rates. While the Reserve Bank of India (RBI) has maintained its repo rate at 6.5% since August 2023, expectations of a prolonged pause—coupled with subdued inflation—could reduce pressure on NBFCs to raise deposit rates further.

4. Risk Mitigation and Credit Quality

Bajaj Finance has addressed rising loan losses (up to ₹1,685 crore in Q1 FY2025 from ₹995 crore a year earlier) by enhancing debt management infrastructure and pruning risky portfolios. A healthier asset quality reduces the need for costly provisions, freeing up capital to invest in lower-cost funding structures.

Risks to the Outlook

• Deposit Competition: Banks and rival NBFCs may retaliate with higher FD rates to retain savers, reversing the downward cost trend.
• Asset Growth Slowdown: A deceleration in loan demand or AUM growth could reduce Bajaj’s ability to offset funding costs.
• Regulatory Headwinds: Stricter NBFC regulations, such as higher capital adequacy norms, might increase compliance costs.

Investment Implications

Bajaj Finance’s projected cost of funds decline aligns with its goal to stabilize NIMs. If realized, the 7.75%-7.85% range could improve profitability, especially as the company’s AAA credit rating (from agencies like CRISIL) provides access to cheap institutional funding. Investors should monitor quarterly deposit growth trends and NII margins to assess progress.

Conclusion: A Prudent Move with Room to Grow

Bajaj Finance’s target to reduce its cost of funds to 7.75%-7.85% reflects strategic adjustments to manage funding pressures while capitalizing on its scale and creditworthiness. With a 25% YoY rise in NII and disciplined risk management, the company is well-positioned to navigate a challenging environment. However, sustained success hinges on executing deposit mix shifts and maintaining asset quality in a competitive market. For now, the 7.75%-7.85% range appears achievable, offering investors a compelling entry point in a sector where cost discipline is key to survival.

Final Statistic: Bajaj Finance’s deposits grew to ₹62,774 crore in Q1 FY2025, a 26% YoY increase, underscoring its ability to scale funding while targeting cost efficiency—a critical step toward its projected margin stabilization.