RBI’s revised risk weights: Impact on lenders, borrowers and the credit landscape

On Thursday, the Reserve Bank of India took action to limit the rapid increase in unsecured personal loans and credit cards. They increased the credit risk weights for these loans, which are generally disbursed without collateral, making it more costly for banks and NBFCs to lend money in this category.

In simpler terms, banks and NBFCs now need to set aside a larger amount of money to cover the risk of these loans before lending money for these types of loans.

As per the press release by RBI, banks and NBFCs will now face a credit risk weight of 125% for consumer loans, excluding home loans, education loans, vehicle loans, microfinance, and gold loans. This is an increase from the previous risk weight of 100%. In the credit card section, the risk weight will now be set at 150%, up from the earlier 125%. Meanwhile, NBFCs will assign a risk weight of 125% to credit card loans, marking an increase from the previous 100%.

But, the question is how it impacts the banks and borrowers. Well, raising the risk weights for lenders has a direct impact on their capital adequacy ratio. They’re required to reserve more capital for these loans, which will probably result in higher costs for borrowers seeking these loans.

In addition to increasing risk weights for unsecured loans, the central bank announced that bank loans to retail NBFCs will also face elevated risk weights. For NBFCs where the extended loans are currently assigned a risk weight below 100%, the RBI stated that the new risk weights will be raised by 25%.

However, this adjustment will not apply to housing finance companies and NBFCs engaged in priority sector lending. These higher lending rates by banks to NBFCs could also spill over to corporate bonds by way of higher yields and widening of credit spreads for NBFCs. Also, the increase in the cost of funds could impact the NBFC’s growth to some extent.

The RBI has also taken measures to curb any excessive lending towards a specific segment of unsecured credit. According to the latest circular, the regulator requires banks and NBFCs to define their exposure limits for unsecured loans. These limits will not only be at the segment level but even at the sub-segment level, the RBI said.

It’s important to note that the guidelines would apply to outstanding loans and new loans. Banks could tinker with lending rates prospectively to adjust for their likely capital erosion. The outstanding loans are already tied at specific lending rates, but the outstanding balances would consume more capital now. The fixed-rate lending rates on unsecured retail credit would be tied to a certain amount of return of capital (built-in credit default) and return on capital (ROA).

Following this news, stocks like SBI Cards, Bajaj Finance, and HDFC Bank tumbled, while the Nifty bank index opened the day with a gap down of over 500 points.

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.