RBI’s Risk Weight Hike on Consumer Credit

Mr. Amit Shroff, CEO of Arvog

“RBI’s Risk Weight Hike on Customer Credit” by Mr. Amit Shroff, CEO of Arvog 

In a recent move, the Reserve Bank of India (RBI) has implemented a significant increase in the risk weight for loans to customers, credit card treatments, and NBFC loans from 100% to 125%. Concerns over the rapid expansion of consumer borrowing have been rising, prompting this decision.

 How will this adjustment impact the dynamics of consumer lending? More importantly, what are the implications for traditional and non-banking lenders? As these questions linger, exploring the potential consequences and navigating the road ahead for consumers and financial institutions is imperative.

 What is a risk weight?

 The RBI mandates banks set aside capital (risk weight) to lend money. The National Housing Bank does the same for housing finance businesses. Basically, it’s how much (shown as the loan percentage) institutions need to conserve for assets. By raising risk weights, the Reserve Bank of India hopes to prepare banks for losses in these categories and prevent overexposure that might threaten the banking system.

 Latest Move on Risk Weights by the RBI

 According to the RBI, unsecured loans, including credit cards, personal loans, and consumer credits, now have higher risk weights. The risk factor for banks lending to non-banking financing businesses that serve this market also increased. The risk weight determines the amount of money that the bank or home loan business must set aside. For example, a house loan of more than Rs 75 lakh carries a risk weight of 125%. Risk weight increases to Rs 1,250 crore for a bank with a Rs 1,000 crore portfolio in loans exceeding Rs 75 lakh.

 The issue of capital adequacy now arises. This figure is 12% for home finance providers, compared to 9% for banks. Simply put, a bank must reserve Rs 112.50 crore, while a home finance firm must set aside Rs 150 crore.

 Effects on Borrowers

 Interest Rates: Borrowers usually pay less in interest when their risk weights are lower. Banks can provide more competitive interest rates on loans when they hold assets with a lower risk weight because they conserve cash. The interest rates on mortgage loans, for instance, are often lower than those on credit cards or personal loans due to the lower risk weights associated with the former.

 Loan price: Risk weights have an indirect impact on loan price. When risk weights are higher, banks have to put more cash into the business, which could cause interest rates on loans to go up.

 Impact on Retail Lending

 Capital Consumption: Due to the higher risk weight restrictions, banks may need to keep more capital to cover these loans, resulting in a 35–100 basis point increase in lending costs. The requirement to raise capital may be greater for PSU banks than for well-capitalised firms.

 Pricing and Growth: Although risk weights have increased, it is unlikely that the expansion of loans would be immediately restricted. This is because there will be a significant demand for credit regardless of interest rate changes. However, lenders and borrowers will closely observe this change since it may affect bank pricing methods.

 The road ahead

 Unsecured loans, such as those for consumer credits, personal loans, and credit card balances, are rising. The marginal cost of these loan segments might increase because of the greater risk provisioning. The effect on loan rates would differ between lenders

 Banks that have a greater proportion of unsecured advances in their loan portfolios could respond more strongly than those that do not. Overall, banks and NBFCs will need more funding to adjust their objectives to rising risk weights while limiting profit margins and NPA risks.

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