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RBI’s Move to Increase Risk Weight for Lending

Context:

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

Relevance:

GS III: Indian Economy

Dimensions of the Article:

  1. Background
  2. Understanding ‘Risk Weights’
  3. Reasons for Regulatory Changes
  4. Chief Concerns
  5. Impact on Consumers
  6. Conclusion

Background:

  • RBI’s Risk Weight Adjustments:
    • RBI has increased the risk weight for consumer loan, credit card exposures, and loans to NBFCs by 25%, reaching a total of 125%.
  • Application Scope:
    • Applies to personal loans, excluding housing loans, education loans, vehicle loans, and loans secured by gold and gold jewellery.
  • Concerns Raised by RBI:
    • RBI expresses concerns about the rapid expansion of consumer loans, prompting this regulatory move.
    • Anticipates potential risks associated with the increasing volume of these types of loans.
  • Impact on Costs:
    • Adjustment leads to higher costs for both banks and non-banking lenders engaged in consumer lending.

Understanding ‘Risk Weights’:

  • Concept of ‘Credit Risk’:
    • Core focus of RBI’s action is to address ‘credit risk.’
    • Refers to the risk linked with a borrower’s inability to fulfill obligations, leading to defaults.
  • Role of ‘Risk Weights’:
    • Essential tool for banks to manage credit risk.
    • Presented in percentage factors, it adjusts for the risk associated with a specific type of asset.
  • Indicator for Risk Management:
    • Indicates the ideal holding percentage that a lender should have to appropriately adjust for the associated risk.
    • RBI has directed an increase in this indicator to align with the perceived rise in risk in consumer lending.

Reasons for Regulatory Changes:

  • Governor’s Concerns:
    • Governor Shaktikanta Das, in October’s monetary policy statement, expressed worries about the “high growth” in specific components of consumer credit.
    • Advised banks and NBFCs to strengthen internal surveillance, address risks, and institute safeguards.
  • Monitoring by RBI:
    • The apex banking regulator closely monitored signs of potential stress in the consumer credit segment.
  • Moody’s Assessment:
    • Higher risk weights aim to curb lenders’ enthusiasm for consumer loan growth.
    • Rapid growth in the unsecured segment exposes financial institutions to elevated credit costs during economic or interest rate shocks.
  • Data on Personal Loans:
    • RBI’s latest figures indicate a 23% YoY increase in unsecured personal loans as of September 22.
    • Outstanding loans from credit cards rose by about 30% during the same period.
  • Concerns for Small Loans:
    • Loans below Rs 50,000 carry high default risk, with delinquencies at 5.4% as of June.
  • Shift in NBFC Focus:
    • Some NBFCs, traditionally focused on secured lending, have shifted to riskier segments.

Chief Concerns:

  • Impact on Capital Adequacy:
    • Primary concerns revolve around the impact on capital adequacy and overall profitability for banks.
    • Capital adequacy ensures banks have sufficient capital to absorb losses from unforeseen events or risks.
  • Asset Quality and Profitability:
    • S&P’s report suggests that slower loan growth and increased risk management could support better asset quality.
    • Estimates a decline of about 60 basis points in Tier-1 capital adequacy.
  • Tier-1 Capital Adequacy:
    • Tier-1 capital adequacy represents banks’ highest-quality capital to absorb losses immediately.
  • Potential Capital Raising:
    • Drop in capital adequacy may prompt lenders with weaker positions to raise capital.
    • Public sector banks generally have lower capital adequacy compared to large private sector banks.
  • Impact on Finance Companies:
    • Finance companies might be worst-affected, facing a surge in incremental bank borrowing and impacting their capital adequacy, according to S&P.

Impact on Consumers:

  • Caution in Credit Extension:
    • With increased risk weightage, banks may exercise caution in extending credit, especially to those with higher perceived risk.
    • Some individuals might find it challenging to obtain credit cards or personal loans.
  • Stricter Terms and Conditions:
    • Eligible consumers may face stricter terms and conditions when availing credit.
    • Lenders could implement more stringent criteria for loan approval.
  • Objective of RBI:
    • RBI’s move to raise risk weightage aims to manage growing defaults and risks associated with unsecured loans.
    • Lenders must account for higher credit risk, leading to pricier lending.
  • Higher Costs for Borrowers:
    • Adjustment in risk weightage will result in higher costs for borrowers taking out unsecured loans.
    • Interest rates in this loan category may see an increase.

Conclusion:

  • Growing Unsecured Loans:
    • Unsecured loans, including personal loans and credit card dues, are experiencing rapid growth.
  • Cost Implications:
    • Due to higher risk provisioning, these loans may become marginally more expensive.
    • Impact on interest rates will vary among lenders.
  • Fundraising Challenges:
    • Both banks and NBFCs need to raise funds while recalibrating priorities based on new risk weights.
    • Balancing profit margins and managing risks from non-performing assets (NPAs) becomes crucial.

-Source: The Hindu


February 2024
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