MUMBAI: In a decisive move to tighten credit control, the Reserve Bank of India (RBI) has raised risk weights for unsecured consumer credits, including personal loans and credit card dues, expressing concern over aggressive lending in these sectors. Mint looks at how the RBI’s move will affect lenders, and how risk weights act as a regulatory tool to modulate demand for loans.
Why are risk weights important?
Risk weights are critical to banking regulation, as they dictate the capital set aside for different types of loans, reflecting their risk profiles. Unsecured loans, which are considered riskier, have higher weights, requiring more capital.
Home loans, for example, attract a risk weight of 35-50%, depending on the size of the loan. In comparison, personal loans will now have a risk weighting of 125%.
How do risk weights affect the use of capital?
The revised risk weights will increase capital consumption for the same loan volume, with a personal loan ₹100 needed now ₹10 of capital instead ₹8 – an indication of the increased risk weighting from 100% to 125%.
Take a case a ₹100 personal loans with a risk weight of 100%. In this case, the value of the asset is risk-weighted ₹100. Now, banks are required to maintain a minimum capital ratio of 8% or common equity level 1 (CET1), including 2.5% in capital conservation buffer. Therefore, for the ₹100 loans mentioned above, used to be capital consumption ₹8. Since RBI has increased the risk weighting by 25 percentage points to 125%, personal loans will now be used ₹10 capital value, which leads to the consumption of more capital for the same value of loans disbursed.
How will this circular affect lenders?
Given the higher capital utilization on existing consumer loans and new loans, lenders would see their core capital ratios decrease. Otherwise, the banks will have to assign higher risk weightings to their loans to non-banking financial companies (NBFCs).
Analysts estimate a contraction in CET1 ratios in the range of 20-85 basis points (bps), including SBI Cards & Payment Services where the core capital ratio is likely to decrease by around 400 bps.
Experts said banks will increase their lending rates on personal loans to compensate for the additional capital requirement.
Suresh Ganapathy, managing director and head of financial services research at Macquarie Capital, said in a note on Friday that non-banking financiers (NBFCs) will bear the brunt of RBI’s move as their cost of funding increases. This is because RBI has increased the RWA (risk weighted assets) on bank funding and also increased risk weighting on their loans, which will affect capital requirements.
According to Ganapathy, fintechs like PayTM that rely on lending partners will also be affected since the financial system will become more wary of unsecured loans.
Meanwhile, S&P Global Ratings said in a statement on Friday that RBI’s changes would not have any immediate impact on its ratings in the Indian financial sector.
What does it say about RBI’s use of risk weights as a regulatory tool?
In September 2019, RBI reduced risk weighting for consumer credit, including personal loans to 100%, from 125% earlier. This did not include credit card receivables and was aimed at improving the flow of credit.
In August 2019, the then deputy governor NS Vishwanathan had said that the central bank increased the risk weighting on such loans to 125% in 2004 when credit growth in the system was overheating .
This time too, the regulator is warning banks against unrestrained growth of unsecured loans and Thursday’s action came after repeated nods. This move is expected to check demand for these loans as banks will now try to compensate for the additional loans ₹2 (explained above) use of capital by increasing interest rates.
As reported earlier, growth in some unsecured loans has significantly outpaced overall credit growth. While credit card outstanding increased 30% year-on-year in September, other personal loans grew 25% and consumer durables rose 11%. Overall bank credit growth was 20% in the same period, RBI data showed.
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