Following weeks of warnings to lenders about the increase in unsecured personal loans, the Reserve Bank of India on Wednesday (15 November) moved in to raise the cost for both banks and non-banking financial companies (NBFCs) in this lending sector by requiring them to set aside more capital.

On Thursday (15 November), the RBI escalated the risk weight on consumer credit by 25 per cent, elevating it from 100 per cent to 125 per cent.

This change implies that banks, which previously had to reserve Rs 9 in capital for every Rs 100 loaned, must now set aside Rs 11.25.

Additionally, the regulator has raised the risk weight on credit card receivables and bank loans to NBFCs, whose risk weight is under 100 per cent.

This directive will elevate borrowing costs for highly-rated finance firms but won’t apply to NBFCs focusing on priority sectors such as housing and small-medium enterprises (SMEs). Home, auto, and education loans remain unaffected by this policy.

Bankers predict that stricter lending regulations may have a more significant impact on NBFCs.

Despite the RBI's hike in risk weightage for unsecured personal loans, NBFCs anticipate no uniform rise in retail lending rates, given the various exclusions set by the regulator.

"The guidelines apply to loans on the consumer side. Gold, home loans, loans to MSMEs for business, MFI & others are excluded. Initial reading suggests that the increase in risk weightage does not apply to loans to housing finance companies and NBFCs which are eligible for classification as priority sector," IIFL Finance group CFO Kapish Jain was quoted as saying by The Economic Times.

"We will have to wait and see what impact the circular will have on interest rates as we interpret the same" he added.

Original Paragraph 7: Bankers suggested that NBFCs will face a bigger impact. "Consumer credit does not constitute a substantial portion of our bank's retail portfolio, nor is it a significant component for most other banks. It is primarily within the NBFCs segment that lenders allocate a significant part of their portfolio to consumer credit," said A S Rajeev, MD & CEO, Bank of Maharashtra. "Bank lending to NBFCs varies between 12% and 15% of their total loans across different banks. However, these loans are predominantly directed to housing finance companies. Consequently, the impact of the new rules will be felt only on around 25% of the overall NBFC portfolio of banks," he added.

A S Rajeev, MD & CEO of Bank of Maharashtra, commented on the expected impacts, stating, "Consumer credit does not constitute a substantial portion of our bank's retail portfolio, nor is it a significant component for most other banks. It is primarily within the NBFCs segment that lenders allocate a significant part of their portfolio to consumer credit,"

"Bank lending to NBFCs varies between 12 per cent and 15 per cent of their total loans across different banks. However, these loans are predominantly directed to housing finance companies. Consequently, the impact of the new rules will be felt only on around 25 per cent of the overall NBFC portfolio of banks," he added.

The heightened capital requirements could result in increased lending rates because the extent of capital needed to be maintained is typically an input in their computation.

Higher lending rates may decelerate growth, although they are also shaped by market competition and demand, not solely by formulas.

The RBI has openly disapproved of certain loan offerings. Bank credit growth has seen an approximate 20 per cent rise, while retail loans have surged by 30 per cent, with credit card debt estimated to have increased by around 30 per cent.

Banks are also extending credit to NBFCs that provide unsecured personal and consumer loans.

ICRA, a ratings agency, forecasts that the revised norms will elevate borrower lending rates.

Furthermore, banks' increased rates may lead to finance companies paying higher interest on their bonds.

Karthik Srinivasan, senior VP at ICRA, explains that the heightened risk weightage is designed to prompt finance companies to bolster their capital reserves.

Although NBFCs currently possess sufficient capital, these new norms will necessitate accelerated capital acquisition to sustain their growth management.

Krishnan Sitaraman, senior director at Crisil Ratings, interprets the RBI's goal as proactively pinpointing sectors with high growth, setting up proper safeguards, enhancing internal monitoring, and ensuring ample capital to regulate growth and fortify balance sheet resilience against potential asset quality risks.

"This way, in the event of any challenges related to asset quality in the days ahead, lenders will be better positioned to manage them" he added.

Under the current rules, when a bank lends to an AAA-rated NBFC, the risk weight stands at 20 per cent, meaning a Rs 100-crore loan is accounted for as Rs 20 crore in capital computation.

Moving forward, this will change to Rs 45 crore as the effective risk weight will increase to 45 per cent from the existing 20 per cent.