Due to the strong growth in unsecured consumer loans, the Reserve Bank of India (RBI) increased the cost of funds for banks and non-banking financial companies (NBFCs), by increasing the risk weighting of these loans. Currently at 100% risk weighting, consumer loans will increase to 125%, excluding loans for housing, education, vehicles and against gold.
Banks create money, so RBI regulates their growth through Capital Adequacy Ratio (CAR) — a function of how much the bank can lose its own money, as a percentage of its loan exposure. The CAR is 10-12% for banks and 15% for NBFCs. Most of those entities keep more than that, to account for growth. When they get close to the limits, they collect money to increase their equity. Consider this: If an NBFC is lending only for unsecured consumer loans, and has a CAR of 20%, it would ₹20 in capital for each ₹100 was lent. The new rules will reduce CAR from 20% down to 16%, since then ₹100 now means 125% exposure, or ₹125.
At 16%, the NBFC is too close to the prudence limits and will therefore have to raise capital. The management will now have to find buyers for their shares, to give more room for growth.
Since financiers are primarily constrained by capital in terms of where to grow, expect them to now narrow their focus on growing consumer loans such as credit cards, buy now pay later and personal loans to more of a variety take ‘sponsored’. And, they will increase the interest rates for such unsecured personal loans, which means that a quick or instant personal loan will be more expensive, in the future.
For NBFCs, there is a double whammy. Not only do they see a hit to their CAR based on who they lend to, they will also be paying more to get a loan. NBFCs have their largest loans from banks, which earlier would get 20% to 50% risk weighting for AAA to A rated NBFCs. Now, these ratios increase to 45-75%, respectively. Banks will compensate this through higher interest rates on such loans, which will increase the cost of funds for the NBFCs.
For credit card receivables, banks will see a 150% risk weighting (from 125%). Only two NBFCs are allowed to issue cards (BoB cards and SBI Cards) and will also see increased risk weights from 100% to 125%.
The impact is mainly on unsecured personal loans, so business loans, housing loans and other secured loans do not see a major impact. Large banks and listed NBFCs will, for the most part, see little impact. One area that will be hit hard, however, is credit card issuers and personal loan financiers, especially those with already relatively low CARs—those will now fall further, and those companies will need to raise more capital meeting.
Some of the recent initiatives launched in the digital world involved the ability to buy products on zero equal monthly installments (EMI), where the manufacturer bears the interest cost to pay you in installments rather than all at once. Since the mechanism for doing this was a funded NBFC or a bank, the interest rates on such loans could rise, reducing the attractiveness of zero-cost EMI for manufacturers. Basically, expect the ‘buy now, pay later’ mechanisms to lose their appeal. Many high-tech lenders may see reduced profitability or reduced margins with the new rules.
What this will do for consumers is increase interest rates on loans, or reduce the availability of easy credit. Expect higher interest rates for new loan applications, and expect to be rejected more often. Clarifications remain to be made as to whether small-ticket microfinance loans from banks are affected, and whether loans backed by fixed deposits and securities also see higher risk weights. As RBI clarifies its stance, the impact on lending rates, disbursement and rejection percentages and capital raising requirements for lenders will become clearer.
While this may be unfortunate for some, RBI seems to have acted to prevent a bigger crisis, due to the strong growth of small ticket personal loans. In the banking industry, too fast growth in any given sector tends to lead to unsatisfactory lending practices, evergreens and ultimately defaults, and the universally recognized way to solve the problem is: the cost on lenders by increasing risk weights.
Deepak Shenoy is founder and CEO at Capitalmind Financial Services, a Sebi-registered portfolio manager, based in Bangalore.
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Updated: 22 November 2023, 12:20 AM IST
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