In response to the unprecedented growth in unsecured retail loans and the consequent concerns regarding rising systemic risk, the Reserve Bank of India has increased the risk weights on unsecured consumer loans, including credit cards, by 25 per cent for both banks and NBFCs.

“We’ve seen unsecured retail growth being relatively higher. One of the ways to stabilise or calibrate growth is to require lenders to provide higher capital for those loans which is a proactive step to enhance guardrails and strengthen internal resilience. Thus, in case there is an increase in NPAs going forward, lenders are better cushioned from a balance sheet perspective. Also, if banks need to keep aside more capital while lending, then they do tend to be more calibrated while lending which can safeguard against aggressive growth,” said Krishnan Sitaraman, Senior Director and Chief Ratings Officer, CRISIL Ratings.

Accordingly, outstanding and new consumer credit exposure of commercial banks and retail loans of NBFCs, excluding housing, education and vehicle loans, and loans secured by gold and gold jewellery, will now attract risk weights of 125 per cent against the current 100 per cent, with immediate effect.

For NBFCs, microfinance and SHG (self-help group) loans will also be excluded from the higher risk weights, the central bank said.

“This is expected to result in higher capital requirements for lenders and hence an increase in lending rate for borrowers. Increase in risk weights for consumer credit is targeted towards NBFCs in the personal and consumption loan segments for augmenting their capital buffers,” said Karthik Srinivasan, Senior Vice-President & Group Head - Financial Sector Ratings, ICRA.

Further, RBI also hiked the risk weights on credit card receivables by 25 per cent. Presently, a risk weight of 125 per cent is applicable on credit card receivables for commercial banks, and of 100 per cent for NBFCs.

Banks’ NBFC exposure

Banks will also have to set aside a 25 percentage point higher risk weight for loans to NBFCs, excluding core investment companies. However, this will only be applicable if the current risk weight, ascertained per the external credit rating assigned to the NBFC, falls below 100 per cent. Loans to HFCs (housing finance companies), and those eligible for classification as priority sector will be excluded.

“The increase in risk weights will only be applicable if the NBFCs are in the AAA, AA or A categories where the risk weights are lower than 100 per cent. Today, if a bank is lending to a AAA-rated NBFC, the risk weight is 20 per cent, which means that a ₹100 crore loan is risk weighted as ₹20 crore for capital computation. Henceforth, it will have to be treated as ₹45 crore because the effective risk weight will be 45 per cent instead of 20 per cent,” Sitaraman said.

Currently, the risk weight for lending to ‘AAA’-rated NBFCs is 20 per cent, for ‘AA’-rated is 30 per cent and for ‘A’-rated NBFCs is 50 per cent.

Srinivasan said bank credit to NBFCs, which are not eligible for priority sector classification, will witness an increase in their cost of funds, which could affect NBFC growth to some extent and also drive demand for securitisation and co-lending.

Strengthen risk management

In addition, all top-up loans extended by banks and NBFCs against movable assets will need to be treated as ‘unsecured loans’ for credit appraisal, prudential limits and exposure purposes.

The central bank also asked lenders to review their sectoral exposure limits for consumer credit, and put in place board approved limits for various sub-segments, especially all unsecured consumer credit exposures, as part of prudent risk management.

These limits will need to strictly adhered to and monitored by the Risk Management Committee on an ongoing basis, it said, setting the deadline for putting in place such board-approved limits by February 29, 2024.

In October 2023, RBI Governor Shaktikanta Das had flagged the high growth in certain components of consumer credit and advised banks and NBFCs to strengthen their internal surveillance mechanisms, address any risk build-up and institute suitable safeguards. Since, then the RBI has also highlighted concerns regarding the increasing dependency of NBFCs on bank borrowings.

Bank credit to NBFCs grew 26.3 per cent y-o-y to ₹14.2-lakh crore as of September 2023. This accounted for 9.4 per cent of bank credit compared with 8.9 per cent a year ago.

While currently most retail-oriented NBFCs are well capitalised to meet these higher risk weights, incrementally higher capital requirements could accelerate capital raises and also spill over to corporate bonds by way of higher yields and widening of credit spreads, industry participants said.