The Reserve Bank of India (RBI) has raised the risk weight for consumer loan, credit card exposures, and loans to non-banking financial companies (NBFCs) by 25 per cent (now standing at 125 per cent), expressing worries about the rapid expansion of these types of consumer loans. This adjustment will result in higher costs for both banks and non-banking lenders engaged in consumer lending.
In the context of credit cards and personal loans, an increase in risk weightage can lead to an increase in the rate of interest. Banks are required to maintain a certain level of capital adequacy to ensure they have enough capital to cover potential losses. The risk weight assigned to different types of loans is a key factor in determining the amount of capital a bank must hold.
If the risk weight for credit card and personal loan portfolios increase, banks may need to allocate more capital to cover these loans, and one way to compensate for this is by increasing the interest rates.
Risk weightage is a measure used in the banking industry to assess the risk associated with different types of assets, including loans. The risk weight assigned to a particular asset influences the amount of capital a bank is required to hold as a buffer against potential losses.
Deepak Shenoy, an X (previously Twitter) wrote in a post: “RBI increases risk weights for banks and NBFCs. This is pretty big! All consumer credit (other than housing, vehicle, gold, edu, and microfinance institutions (MFI) loans) see an increase in risk weight to 125 per cent from 100 per cent.”
In the wake of a slowdown in consumer loans, banks have been aggressively offering loans to retail customers. They even started providing top-up loans on auto loans, which are essentially disguised as unsecured credit. A top-up loan is an extra credit given on top of an existing loan during a balance transfer, and it comes with fewer restrictions and minimal documentation.
For instance, Rohan Sharma, 40, was looking to purchase a car. Instead of pledging any collateral, he decided to apply for an unsecured auto loan from a bank. The bank, based on Sharma’s credit history and financial standing, approved the loan without requiring any specific asset as security. In this scenario, Rohan’s auto loan is unsecured, meaning there is no particular asset tied to the loan, and the bank cannot directly seize the car if Rohan defaults on the repayments.
However, RBI has intervened to curb this practice by tightening capital norms. It now classifies top-up loans as unsecured loans and has increased the risk weight on various unsecured loans, such as personal loans and credit card receivables. This makes it more challenging for banks to easily and freely extend loans to consumers.
Mahesh Shukla, CEO and founder, Payme, a digital lending firm says that as risk weightage increases, banks may become more cautious in extending credit to consumers, especially those with a higher perceived risk.
“This could result in some individuals finding it more challenging to obtain credit cards or personal loans. Those who are still eligible for credit might face stricter terms and conditions. If a bank raises interest rates on existing credit card balances or personal loans due to increased risk weightage, it directly affects consumers who already have outstanding debt. This can lead to higher monthly payments and increased overall borrowing costs for existing borrowers,” Shukla adds.
According to experts, by increasing risk weightage, the RBI aims to manage the growing defaults and risks linked to unsecured loans. Lenders will now need to account for higher credit risk in this loan category, thus making lending pricier. This adjustment will also result in higher costs for borrowers taking out these loans.
The RBI has noticed a significant rise in unsecured lending and early signs of payment issues in this loan category. Even though it might seem like a small part of the whole scenario, the RBI is being careful and has taken early measures to address and control this trend.
During the bi-monthly monetary policy review in October 2023, RBI Governor Shaktikanta Das expressed worry about the fast-paced increase in unsecured personal loans. While no immediate measures were announced to limit such lending, the RBI’s unease with the rise in unsecured personal loans was clear.
Says Ameet Venkeshwar, Chief Business Officer at LoanTap, a digital lending platform. “Since now banks and NBFCs will have to set aside a higher capital against the unsecured loan segment, it will make lending in the segment more expensive for banks and NBFCs. In turn, this will make loans more expensive for borrowers. While it will not affect home loans, education loans, vehicle loans, and gold loans, the unsecured loan market will be affected. This move by RBI has come in because of the high increase in unsecured lending and initial delinquency trends seen in the unsecured loan segment. Overall, it is a move to control the increasing delinquencies and high risks associated with lending in the unsecured loan segment.”
“This move is to control the initial delinquency trend in the unsecured lending segment. While it will make lending more expensive for the lender, the overall lending process for the borrower may still remain the same. What this signifies is that banks and NBFCs will need to have more cover for credit risk in the unsecured segment,” he adds.
Vikas Singh, CEO and co-founder, Sugamya Finance, said that it was essential to acknowledge the potential rise in both the cost of funds and lending rates for the industry as a whole.
“While our existing cost of funds is already relatively high and unlikely to escalate further, there is a growing concern for our peers who may encounter challenges in this aspect. This situation may lead lenders to exercise greater caution in advancing funds, prompting an increase in lending rates for borrowers. Consequently, this could drive a surge in demand for securitisation, and co-lending may see an uptick as well,” he adds.
However, according to some experts, the new risk weights are not likely to change anything for eligible customers. Lenders will still prefer to do business with borrowers who have stable incomes, high credit scores, and a track record for timely payments.
“Those borrowers will continue to get the best offers. Their existing credit lines will also not be impacted. For anyone else, credit will remain relatively costlier regardless of risk weights. Demand for credit has remained sky high despite soaring interest rates, so it would be interesting to see if the new measures slow things down,” says Adhil Shetty, CEO, BankBazaar.com, a financial services website.
Shetty adds: “Unsecured loans, i.e., personal loans, consumer durables, and credit card dues, are growing rapidly. Due to higher risk provisioning, these segments of loans may get marginally costly. The interest rate impact would vary from lender to lender. Banks with relatively higher exposure to unsecured advances on their loan books may react more sharply than banks that don’t have it. On the whole, both banks and NBFCs will have to raise funds in a manner that helps them to calibrate their priorities to the new risk weights, while controlling profit margins and risks from non-performing assets (NPAs).”