bl explainer: What does RBI’s decision to raise risk weights mean to the borrower?

What are risk weights?

Every rupee lent by the bank is a cost or has an implication on its capital position. Depending on the nature of the loan and the inherent risk associated with it, risk weights are attributed. Banks have to ensure that their capital is enough to cover these risk weighted assets.

Total assets as disclosed in the financials and total risk weighted assets are different things. Each asset class has varying risk weights. For instance, risk weights for home loans could range from 50 per cent to 75 per cent, for gold loans it is 75 per cent. Corporate loans are charged 100 per cent given the risk they carry.

How do they affect borrowers?

Lower the risk weight, lower the rate of interest. This is the thumb rule. Therefore, risk weights impact borrowers indirectly and is felt through the pricing of loans.

For instance, home loans have the lowest interest rate among retail products because lower risk weights allow banks to pass on the advantage of capital consumption. Personal loans and credit cards have the highest interest rate because of their tenure and charge on capital.

What did the RBI do last week with risk weights?

The RBI increased the risk weight on categories of unsecured loans namely credit cards, consumer durable loans and personal loans. Bank lending to non-banking finance companies which are catering to this segment will see an increase in risk weights to 125 per cent as against the present 100 per cent.

Why is the RBI worried about consumer loans?

For the banking system, share of unsecured loans has risen to 10 per cent and has been the fastest growing segment in the last two years. These loans are including consumer durable loans, largely used for self-consumption or to acquire non-income generating assets.

Since it is not possible to monitor the end use of these loans, the true repayment ability of the borrower cannot be ascertained. The saving grace is that these loans are granular or small-ticket in nature and have not reached a stage where it could be a threat to the banking system.

However, considering that the growth in this segment has been disproportionately high, the regulator may have wanted to nip the problem in the bud before it can get out of hand.

What will be the impact of this move on retail loans?

The new risk weight limits could consume 35-100 bps more capital than the current level. However, since the lenders are well capitalsed (at least 400-500 bps above the eight per cent statutory threshold), the need to raise money in the near term may not arise. PSU banks on the other hand may be just over 100-140 bps.

That said, until now, given that demand has been buoyant irrespective of the rate of interest (including loans availed through fintech apps), they may not curb growth immediately, though the overall pricing power of banks will be closely watched.

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