What is RBI’s latest move to increase risk weight for lending about? | Explained

The RBI recently issued regulatory measures to banks and NBFCs to increase risk weights associated with consumer credit and bank credit by an additional 25 percentage points. We examine the rationale behind the move and its potential impact.

The story so far: Seeking to rein in an observed rise in unsecured personal loans and credit cards, 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. This would be applicable to unsecured personal loans, credit cards and lending to NBFCs. The directions are expected to result in higher capital requirements for lenders and thereby, an increase in lending rates for consumers. They come into force with immediate effect, with mandatory adherence being sought before February-end next year.  

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.  

Earlier, in interactions with the MDs and CEOs of major banks, RBI had raised concerns about the growth seen in consumer credit and increased dependency of NBFCs on bank borrowings.  

Now, it 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. 

Lastly, bank credit to NBFCs, excluding core investment companies, also had their risk weights increased by 25 percentage points. This is over and above the risk weights on such exposures assigned by an accredited external assessment institution (a mandatory requirement). The direction would be applicable in all cases where the extant risk weight as per the external rating is below 100%. This would however not apply to housing finance companies and loans to NBFCs classified into the priority sector.