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Economy
Mahesh

29/11/23 12:23 PM IST

RBI’s latest move to increase risk weight for lending

In News
  • The Reserve Bank of India (RBI) directed banks and non-banking financial companies (NBFCs) to reserve more capital for risk weights. The mandatory risk weight requirement has been increased by 25 percentage points.
RBI new rules
  • The idea is to address the notion of ‘credit risk.’ It refers to the risk entailed by a borrower being unable to meet their obligations or defaulting on commitments.
  • ‘Risk weights’ are an essential tool for banks to manage this risk.
  • This metric, in percentage factors, adjusts for the risk associated with a certain asset type.
  • In other words, it is an indicator of the essential holding the lender should ideally have to adjust the associated risk. This is what the RBI has directed be increased.
  • The primary purpose for effective risk management by banks is to maximise their returns by maintaining credit risk exposure within acceptable parameters.
  • RBI has directed that the risk weight for consumer credit exposure be increased by 25 percentage points to 125%, for all commercial banks and NBFCs.
  • This would apply to personal loans, excluding housing loans, education loans, vehicle loans and loans secured by gold and gold jewellery. This would also not apply to SHG loans and microfinance. At present, exposures in this realm mandate a risk weight of 100%. 
  • Credit card loans of scheduled commercial banks (SCBs) currently attract a risk weight of 125% while that of NBFCs attract 100%.
  • The apex banking regulator has decided to increase the risk weight on such exposures by 25 percentage points, thus, placing the risk weight at 125% for NBFCs and at 150% for SCBs.
Reason for new proposals
  • Recently, the RBI had flagged concerns about the “high growth” in “certain components of consumer credit.
  • Ratings agency Moody’s also put forth that higher risk weights are intended to “dampen lenders’ consumer loan growth appetite.”
  • The unsecured segment has grown rapidly in the past few years, exposing financial institutions to a potential spike in credit costs in the event of a sudden economic or interest rate shock.
  • RBI’s latest figures stipulate that unsecured personal loans have increased approximately 23% on a year-over-year basis, as on September 22 this year.
  • Outstanding loans from credit cards increased by about 30% during the same period.
  • Major concerns emerge for loans below Rs 50,000 – these carry the utmost default risk.
  • Ratings agency S&P in their assessment held that borrowers in this segment are often highly leveraged and may have other lending products.
  • Loans of this kind comprise only 0.3% of total retail loans.
  • Financial technology firms are more exposed to these loans, as around 80% of their personal loans is to this customer segment.
  • According to Moody’s, several NBFCs that until now focussed on secured lending categories (such as infrastructure, real estate and vehicle loans) have pivoted to riskier segments. Additionally, net interest margins (an important profitability metric for banks) are declining because of steep competition.
Concerns
  • The primary concerns relate to the impact on capital adequacy and the bank’s overall profitability. The latter ensures that banks have sufficient capital to absorb losses arising out of unanticipated events or risks within the business.
  • S&P’s latest report states that slower loan growth and an increased emphasis on risk management will likely support better asset quality in the Indian banking system.
  • The immediate effect will likely be higher interest rates for borrowers, slower loan growth for lenders, reduced capital adequacy, and some hit on profits.
  • The ratings agency estimates Tier-1 capital adequacy will decline by about 60 basis points. Tier-1 capital adequacy represents banks’ highest quality of capital as it helps banks absorb losses immediately as and when they occur.
  • According to S&P, the drop may prompt lenders with weaker capital adequacy to raise capital. Unrelatedly, it observed that public sector banks generally have lower capital adequacy than large private sector banks.
  • However, the worst-affected might be finance companies, as their incremental bank borrowing might surge, besides the impact on their capital adequacy, S&P states.
  • NBFCs face a “double-whammy” 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 the entities (excluding core investment companies) as of March end.
  • It is expected that the increased costs would be passed onto borrowers; inability to do so would translate to a hit on profit.
Source- The Hindu

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