After the Reserve Bank of India (RBI) rolled back the higher risk weight assigned for bank loans to NBFCs in 2023, brokerage firms and analysts said that the easing norms is positive for the sector. An analysis report by Nuvama stated, “After very tight regulations in the last 1.5 years the RBI is easing norms, which is positive for the sector. Given deteriorating asset quality in a few segments, banks are unlikely to chase aggressive growth in mid-sized NBFC and MFIs but RBI’s easing stance will be positive for loan growth when the environment stabilises and system liquidity improves.” The central bank has also lowered risk weight requirements for loans extended by banks to microfinance firms.
A lower risk weight will mean that lenders need to set aside less funds as a safety net for consumer loans, implying an increase in their lending capacity.
The central bank came out with two notifications yesterday: a) microfinance loans in the nature of consumer credit (not qualifying for regulatory retail) shall be risk weighted at 100 per cent, (b) risk weights applicable to NBFCs rated A and above restored to pre-16th Nov’23 levels, again, cutting risk weights by 25ppts, on the book. This, JM Financial said, will benefit the banks with NBFC and MFI exposure, freeing up capital for growth.
Why did RBI increase risk weights in 2023?
Following the October 2023 MPC meet, the then RBI Governor Shaktikanta Das had flagged high growth in components of consumer credit and had advised banks and NBFCs to address the build-up of risks. Subsequently, on 16th November 2023, the RBI issued notifications to:
– Raise the risk weights in respect of consumer credit exposure of commercial banks and including personal loans, but excluding housing loans, education loans, vehicle loans and loans secured by gold and gold jewellery, by 25ppts to 125 per cent. The weight on non-consumer credit exposure (qualifying for regulatory retail portfolio) was not changed.
– Raise the risk weights applicable to NBFCs where the risk weight as per external rating of NBFCs was below 100 per cent (NBFCs rated A and above) by 25ppts.
How will change in microfinance exposures impact banks and NBFCs? The change in microfinance exposures will lead to freeing up of capital for banks. According to Motilal Oswal Financial Services (MOFSL), “The reversal in risk weights on MFI loans from 125 per cent to 100 per cent/ 75 per cent will help reduce RWAs for banks, supporting capital adequacy levels. Universal banks like Bandhan, IIB, IDFCFB, RBK, and some SFBs with significant exposure to the microfinance sector will be the key beneficiaries. The improved capital position will enable some of these banks to operate with optimal leverage, thus supporting their RoE and alleviating the need to raise capital in the short term.” Further, with the RBI, in its November 2023 notification excluding microfinance/SHG loans of NBFCs, hence, risk weights on MFI exposure of NBFCs remained untouched.
How will change in NBFC exposures impact banks and NBFCs? The risk weights for NBFCs rated A and above are reduced by 25ppts. JM Financial said, “Following the increased risk weights on NBFC exposure, banking credit growth to NBFCs had reduced from 22.1 per cent YoY in Oct’23 to 6.6 per cent YoY by Dec’24. This is likely to normalise going ahead.” Further, among NBFCs, the brokerage firm said, benefit on blended on cost of borrowings is expected to be under 0.1 per cent, with Five-Star Business Finance and L&T Finance expected to see highest improvement.
Who will benefit from the latest announcements?
The roll back in risk weights for MFIs shall benefit all MFI-heavy banks, but not SFBs because other than AU no SFB had raised risk weights on MFI loans to 125 per cent, stated a report by Nuvama. “Banks that had hiked risk weights include Bandhan, RBL, IDFC First and IIB. These banks shall see improvement in CAR, but Bandhan and RBL shall likely benefit most. Banks that have a high exposure to NBFC include IDFC First, ICICI and BoB. Lower risk weight on NBFC loans shall result in a lower CoF for NBFCs especially those that have a high share of bank borrowings,” the brokerage firm said.
JM Financial added, “Ujjivan SFB, Bandhan Bank and Equitas SFB will be most positively impacted. We estimate Tier- I capital for Bandhan Bank to rise by 1.7 per cent to 15.5 per cent while Ujjivan and Equitas SFB should see their Tier- I capital rise by 5.5 per cent and 1.0 per cent, respectively.
ICICI Securities too said, “Basis 100 per cent risk weights (vs 125 per cent currently), we calculate Bandhan could be the biggest beneficiary with ~170bps CET 1 accretion. We see healthy ~25-50bps CET 1 accretion for RBL, IIB, DCB and IDFCFB. Banks with sizeable MFI exposure such as RBL, IIB, IDFCFB, etc., could see additional 10-30bps CET 1 in case the entire MFI exposure is counted as RRP. Bandhan would likely gain substantial ~140bps additional CET 1 in this case. On MFI growth, we highlight that the current slowdown in MFI is mostly due to asset quality caution, and lower risk weights may have limited impact on boosting loan growth in near term.”
However, Nuvama maintained that given increasing risks in the sector, the brokerage firm does not see banks going aggressive like before on NBFC lending even with this relaxation.
Will it revive credit growth?
Lower risk weights will release more bank capital and enable more lending to NBFCs and MFIs. Higher-rated NBFCs will be able to borrow from banks at a lower cost. However, Nomura’s Chief Economist, Sonal Varma said, “We expect policy transmission to take more time. Banks are still struggling with tight liquidity conditions, consumer incomes have moderated and delinquencies have risen in the MFI segment, which is likely to keep lenders more risk averse for the time being.”
That said, Nomura maintained, policies are moving in the right direction. However, per the brokerage firm, leading indicators suggest the economy remains in a cyclical downturn, so further policy support will be needed to stabilise growth. “We forecast GDP growth of 6.0 per cent YoYin FY25 and 5.9 per cent in FY26, below consensus and the RBI (6.3-6.7 per cent). We continue to expect 75bp of additional rate cuts, more than consensus (25-50bp), to a terminal rate of 5.50 per cent by end-2025. More easing via liquidity and macroprudential policies to accelerate policy transmission is likely on the cards.”
To conclude…
While the 25 per cent reduction in risk weights, in isolation, may not be a significant incentive for banks to lend to NBFCs—since many are already grappling with elevated CD ratios, asset quality issues, and margin pressures— MOFSL maintained that the intent behind this regulatory action and the timing of the reduction in risk-weight when the system is dealing with heightened asset quality issues, particularly in MFI, are crucial.
The announcement definitely is a change of heart from the central bank with the RBI Governor Sanjay Malhotra, at the recent media meet on February 7, 2025, had clarified that the RBI is unlikely to relax risk weights on NBFC loans because of interconnected risks. Even after this, the RBI relaxed risk weights on NBFC loans of banks. “This possibly happened after the governor recently met CEOs of NBFCs and banks. The NBFCs would have asked for this relaxation. The RBI under the new Governor is adopting a more consultative approach than earlier,” Nuvama concluded.