The Reserve Bank of India (RBI) has decided to raise risk weight on bank lending to those non-banking financial companies (NBFCs) where risk weights are below 100 per cent, by 25 percentage points. The move by RBI is expected to have significant ramifications, affecting loan growth, lending rates, and capital adequacy, particularly for weaker lenders .
What is risk weight and why does it matter?
Risk weight is a measure of the credit risk associated with a loan or an asset. It determines how much capital a bank needs to set aside to cover potential losses from the loan or asset. The higher the risk weight, the more capital the bank needs to maintain, and vice versa.
The RBI assigns different risk weights to different types of loans and assets, based on their perceived riskiness. For example, loans to central and state governments have zero risk weight, while loans to corporates have risk weights ranging from 20 per cent to 150 per cent, depending on their credit ratings.
By raising the risk weight on bank lending to NBFCs, the RBI has effectively increased the cost of funds for NBFCs, as banks will charge higher interest rates to compensate for the higher capital requirement. This will also reduce the profitability and return on equity (ROE) of banks, as they will have to allocate more capital for the same amount of lending.
How will this affect NBFCs and banks?
The RBI’s move is likely to have a differential impact on NBFCs and banks, depending on their size, business mix, and capital position.
According to a report by ICRA Ratings, the impact of the higher risk weight will be more pronounced for NBFCs that rely heavily on bank funding, especially those that are engaged in consumer lending, such as personal loans, credit cards, and vehicle loans. These NBFCs will face higher borrowing costs and lower credit growth, as banks may reduce their exposure or demand higher collateral .
On the other hand, NBFCs that have diversified sources of funding, such as bonds, commercial papers, and securitisation, will be less affected by the RBI’s move. These NBFCs may also benefit from lower competition from bank-funded NBFCs in certain segments, such as housing finance, microfinance, and small business loans.
For banks, the impact of the higher risk weight will depend on their exposure to NBFCs and their capital adequacy ratios (CAR). According to a report by Crisil Ratings, large private sector banks will face a higher impact of about 80 basis points on their CAR, as they have higher exposure to NBFCs (about 10 per cent of their loan book) and lower risk weights (about 75 per cent on average) . However, these banks also have strong capital buffers and profitability, which will help them absorb the impact.
On the other hand, public sector banks (PSBs) and small private sector banks will face a lower impact of about 20-30 basis points on their CAR, as they have lower exposure to NBFCs (about 6 per cent of their loan book) and higher risk weights (about 100 per cent on average) . However, these banks also have weaker capital buffers and profitability, which will limit their ability to lend more.
What are the implications for the economy?
The RBI’s move is seen as a prudential measure to address the systemic risks posed by NBFCs, which have grown rapidly in recent years and have become an important source of credit for various sectors of the economy. The RBI has also introduced scale-based regulation for NBFCs, which will subject them to stricter norms based on their size and activities .
However, some experts have raised concerns that the RBI’s move may have unintended consequences for the economy, such as slowing down credit growth, increasing financial exclusion, and hampering recovery from the pandemic-induced slowdown. They argue that NBFCs play a crucial role in providing last-mile credit to underserved segments of the economy, such as small businesses, rural households, and informal workers. They also point out that NBFCs have improved their asset quality and liquidity position in recent months, with support from various policy measures .
Therefore, they suggest that the RBI should adopt a more calibrated and differentiated approach to regulating NBFCs, taking into account their business models, risk profiles, and contribution to the economy. They also urge the RBI to provide adequate liquidity and refinancing facilities to NBFCs, especially those that cater to priority sectors and social sectors .
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