Mint Explainer: Why RBI raising risk weights for consumer loans is significant

RBI has raised risk weights on consumption loans, credit card exposures and loans to non-bank financiers by 25 percentage points each.
RBI has raised risk weights on consumption loans, credit card exposures and loans to non-bank financiers by 25 percentage points each.


  • Tightened regulations to impact capital ratios and lending rates

Mumbai: In a decisive move to tighten credit control, the Reserve Bank of India (RBI) on Thursday raised risk weights for unsecured consumer credits, including personal loans and credit card dues, signalling its concerns over aggressive lending in these sectors. Mint takes a look at how the RBI’s move will impact lenders, and how risk weights act as a regulatory tool to modulate loan demand.

Why do risk weights matter?

Risk weights are pivotal in banking regulation, as they dictate the capital set aside for different loan types, reflecting their risk profiles. Unsecured loans, perceived as riskier, have higher weights, thus requiring more capital. 

Home loans, for instance, attract a risk weight of 35-50%, depending on the size of the loan. In comparison, personal loans will now have a risk weight of 125%.

How do risk weights affect capital usage?

The revised risk weights will heighten capital consumption for the same loan volume, with a personal loan of 100 now necessitating 10 of capital instead of 8 - a reflection of the increased risk weight from 100% to 125%.

Take the case of a 100 personal loan with a risk weight of 100%. In this scenario, the value of the risk-weighted asset is 100. Now, banks are required to maintain a minimum of 8% core capital ratio or common equity tier 1 (CET1), which includes 2.5% in capital conservation buffer. Therefore, for the 100 loan mentioned above, capital consumption used to be 8. Since RBI has increased the risk weight by 25 percentage points to 125%, personal loans will now use 10 worth of capital, thereby leading to greater capital consumption for the same value of loans disbursed.

What will be the impact of this circular on lenders?

Given the higher capital usage on existing as well as fresh consumer loans, lenders would see a dip in their core capital ratios. That apart, banks will also have to assign higher risk weights for their loans to non-banking financial companies (NBFCs). 

Analysts estimate a contraction in CET1 ratios in the range of 20-85 basis points (bps), barring SBI Cards & Payment Services where core capital ratio is likely to contract 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, in a note on Friday said that non-banking financiers (NBFCs) will bear the brunt of RBI's move as their funding cost will increase. This is because RBI has increased the RWA (risk-weighted assets) on bank funding and also increased risk-weights on their loans which will affect capital requirements. 

According to Ganapathy, fintechs like PayTM which depend on lending partners will also get affected since the financial system will become more cautious on unsecured loans. 

Meanwhile, S&P Global Ratings said in a statement on Friday that RBI’s changes would not have any immediate effect on its Indian financial sector ratings.

What does it say about RBI’s use of risk weights as a regulatory tool?

In September 2019, RBI had reduced risk weight 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 of 2019, then deputy governor NS Vishwanathan had said that the central bank had increased the risk weight on such loans to 125% in 2004 when credit growth in the system was heating up excessively. 

This time around, too, the regulator has been warning banks against unbridled growth in unsecured loans and the action on Thursday came after repeated nudges. This move is expected to check demand for these loans as banks will now try to compensate for the additional 2 (explained above) capital usage by increasing interest rates. 

As reported earlier, the growth in some unsecured loans has outstripped total credit growth by a wide margin. While credit card outstanding increased 30% year-on-year in September, other personal loans grew 25% and consumer durable loans rose 11%. Overall bank credit growth was 20% in the same period, showed RBI data.

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