Risk Weights: RBI’s latest move to increase risk weights for lending

Source: The post is based on the article “Risk Weights: RBI’s latest move to increase risk weights for lending” published in “The Hindu” on 29th November 2023

Why in the News?

Reserve Bank of India (RBI) has directed banks and non-banking financial companies (NBFCs) to reserve more capital for risk weights. 

What are Risk Weights?

1) The RBI wants to tackle the problem of ‘credit risk,’ which is the possibility of loss due to a borrower defaulting on a loan.

2) Risk weights are an essential tool for banks to manage this risk. It is a percentage indicating how much capital a lender should ideally hold to cover the associated risk.

3) Risk weights are assigned based on the associated risk of default. For example, higher risk weights for unsecured personal loans.

What is RBI’s recent move related to risk weights?

1) Increase in Risk Weight for Consumer Credit: RBI has increased it by 25 percentage points, from 100% to 125% for commercial banks and NBFCs. This applies to personal loans (and retail loans for NBFCs), excluding housing, education, vehicle loans, and loans secured by gold.

2) Credit Card Loans: Presently, scheduled commercial banks have a risk weight of 125% for credit card loans while NBFCs have 100%.The RBI plans to increase this to 150% and 125%, respectively.

3) Bank Credit to NBFCs: The risk weight for bank credit to NBFCs is being increased by 25 percentage points. However, this does not apply to housing finance companies and loans to NBFCs classified into the priority sector.

What will be the impact of these decisions taken by RBI?

1) Immediate impact on borrowing: It will lead to higher interest rates for borrowers, slower loan growth for lenders, reduced capital adequacy (as the loan growth slows down, they will have to maintain lesser capital to meet the capital adequacy requirement) and some hit on profits.

2) Brings down the growth of unsecured consumer loans: The higher capital requirement is expected to moderate the excessive growth of unsecured consumer loans.

3) Impact on NBFCs: NBFCs will face the most impact because of higher risk weights on their unsecured loans and on account of the bank lending mandates to NBFCs.

– Bank lending to NBFCs remained the principal source of funding for NBFCs constituting 41.2% of the total borrowing of entities as of March,2023.

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