Context:
The Reserve Bank of India (RBI) has directed banks and non-banking financial companies (NBFCs) to reserve more capital for risk weights.
Relevance:
GS III: Indian Economy
Dimensions of the Article:
- Background
- Understanding ‘Risk Weights’
- Reasons for Regulatory Changes
- Chief Concerns
- Impact on Consumers
- Conclusion
Background:
- RBI’s Risk Weight Adjustments:
- RBI has increased the risk weight for consumer loan, credit card exposures, and loans to NBFCs by 25%, reaching a total of 125%.
- Application Scope:
- Applies to personal loans, excluding housing loans, education loans, vehicle loans, and loans secured by gold and gold jewellery.
- Concerns Raised by RBI:
- RBI expresses concerns about the rapid expansion of consumer loans, prompting this regulatory move.
- Anticipates potential risks associated with the increasing volume of these types of loans.
- Impact on Costs:
- Adjustment leads to higher costs for both banks and non-banking lenders engaged in consumer lending.
Understanding ‘Risk Weights’:
- Concept of ‘Credit Risk’:
- Core focus of RBI’s action is to address ‘credit risk.’
- Refers to the risk linked with a borrower’s inability to fulfill obligations, leading to defaults.
- Role of ‘Risk Weights’:
- Essential tool for banks to manage credit risk.
- Presented in percentage factors, it adjusts for the risk associated with a specific type of asset.
- Indicator for Risk Management:
- Indicates the ideal holding percentage that a lender should have to appropriately adjust for the associated risk.
- RBI has directed an increase in this indicator to align with the perceived rise in risk in consumer lending.
Reasons for Regulatory Changes:
- Governor’s Concerns:
- Governor Shaktikanta Das, in October’s monetary policy statement, expressed worries about the “high growth” in specific components of consumer credit.
- Advised banks and NBFCs to strengthen internal surveillance, address risks, and institute safeguards.
- Monitoring by RBI:
- The apex banking regulator closely monitored signs of potential stress in the consumer credit segment.
- Moody’s Assessment:
- Higher risk weights aim to curb lenders’ enthusiasm for consumer loan growth.
- Rapid growth in the unsecured segment exposes financial institutions to elevated credit costs during economic or interest rate shocks.
- Data on Personal Loans:
- RBI’s latest figures indicate a 23% YoY increase in unsecured personal loans as of September 22.
- Outstanding loans from credit cards rose by about 30% during the same period.
- Concerns for Small Loans:
- Loans below Rs 50,000 carry high default risk, with delinquencies at 5.4% as of June.
- Shift in NBFC Focus:
- Some NBFCs, traditionally focused on secured lending, have shifted to riskier segments.
Chief Concerns:
- Impact on Capital Adequacy:
- Primary concerns revolve around the impact on capital adequacy and overall profitability for banks.
- Capital adequacy ensures banks have sufficient capital to absorb losses from unforeseen events or risks.
- Asset Quality and Profitability:
- S&P’s report suggests that slower loan growth and increased risk management could support better asset quality.
- Estimates a decline of about 60 basis points in Tier-1 capital adequacy.
- Tier-1 Capital Adequacy:
- Tier-1 capital adequacy represents banks’ highest-quality capital to absorb losses immediately.
- Potential Capital Raising:
- Drop in capital adequacy may prompt lenders with weaker positions to raise capital.
- Public sector banks generally have lower capital adequacy compared to large private sector banks.
- Impact on Finance Companies:
- Finance companies might be worst-affected, facing a surge in incremental bank borrowing and impacting their capital adequacy, according to S&P.
Impact on Consumers:
- Caution in Credit Extension:
- With increased risk weightage, banks may exercise caution in extending credit, especially to those with higher perceived risk.
- Some individuals might find it challenging to obtain credit cards or personal loans.
- Stricter Terms and Conditions:
- Eligible consumers may face stricter terms and conditions when availing credit.
- Lenders could implement more stringent criteria for loan approval.
- Objective of RBI:
- RBI’s move to raise risk weightage aims to manage growing defaults and risks associated with unsecured loans.
- Lenders must account for higher credit risk, leading to pricier lending.
- Higher Costs for Borrowers:
- Adjustment in risk weightage will result in higher costs for borrowers taking out unsecured loans.
- Interest rates in this loan category may see an increase.
Conclusion:
- Growing Unsecured Loans:
- Unsecured loans, including personal loans and credit card dues, are experiencing rapid growth.
- Cost Implications:
- Due to higher risk provisioning, these loans may become marginally more expensive.
- Impact on interest rates will vary among lenders.
- Fundraising Challenges:
- Both banks and NBFCs need to raise funds while recalibrating priorities based on new risk weights.
- Balancing profit margins and managing risks from non-performing assets (NPAs) becomes crucial.
-Source: The Hindu