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The Reserve Bank of India (RBI) has recently introduced strict rules for personal loans and credit cards by increasing capital requirements. In this blog, we will decode RBI’s Unsecured Lending Norms. Under the new regulations, banks and NBFCs are now required to maintain higher capital for each loan issued, with a 25-percentage-point rise in risk weights. This specifically applies to retail loans, including personal and credit card loans, where the risk weight has increased from 100% to 125%.
Also, the RBI has increased risk weights for credit card exposures by 25 percentage points, setting them at 150% for banks and 125% for NBFCs. Remember certain loans, such as housing, education, vehicle loans, and those secured by gold or gold jewelry, are exempt from these revised risk weight guidelines. This move aims to strengthen the financial system while ensuring specific loan categories remain unaffected by the increased risk weights.
In response to these regulatory changes, all banks and NBFCs must establish board-approved limits for unsecured consumer credit exposures by February 29, 2024. The RBI stated that any additional loans financial institutions provide against assets like vehicles, which naturally decrease in value over time, will be considered unsecured loans for credit assessment, prudential limits, and exposure calculations.
After this news, financial service providers, including SBI Cards, RBL Bank, ICICI Bank, Cholamandalam Investment and Finance Company, and Bajaj Finance, are already facing pressure on their shares.
- What is 'risk weight,' and what exactly has RBI done?
Risk weight is like a safety cushion that banks and financial institutions use to cover potential losses on loans. When the Reserve Bank of India (RBI) talks about changing the risk weight, it means adjusting the percentage of money these institutions need to keep aside as a safety measure.
Let’s break it down.
Imagine you are lending money, and initially, you had to keep 100 rupees in reserve for every 100 rupees you lent (that’s the risk weight of 100%). With the new rules, if the risk weight increases to 125%, you’d need to set aside 125 rupees instead of 100 for the same loan.
This change in risk weight impacts banks and non-banking financial companies (NBFCs). With a higher risk, they must keep more money aside as a safety net, especially for loans with less collateral (unsecured category). So, the bottom line is the RBI’s move increases the amount of money these institutions need to reserve, affecting how much they can lend in specific categories and their overall financial health.
- Why has RBI increased the risk weight on assets for unsecured lending, including personal and credit card loans?
The RBI’s recent circular aligns with its concerns expressed during the last monetary policy review regarding the rapid growth in unsecured lending. This concern is grounded in data indicating early signs of delinquency. According to the central bank, the worry stems from an unusually high surge in these types of loans, specifically in personal loans and credit cards, surpassing the overall bank credit growth of approximately 15% in the past year.
- Impact of RBI's new norms on lenders?
The recent shift will make financial institutions, including banks, NBFCs, and fintechs, more cautious when considering unsecured lending. The alteration in risk weightage implies that banks will need higher capital, affecting their lending rates. For banks to maintain risk-adjusted returns, lending rates must increase. We may see a slowdown in the growth of unsecured lending in the next 3-6 months, prompting lenders to be more selective in extending credit in the unsecured space.
- Will RBI's new norms impact borrowers? Will lending rate increase?
Kotak Mahindra Bank’s Diwanji predicts lending rates could rise between 40 bps and 75 bps, impacting lenders’ ROEs and Morgan Stanley’s suggestion that borrowing could increase-lending rates within the financial landscape.
- Will RBI's move affect online lending apps and NBFCs?
Many online lending apps primarily get their funds from other NBFCs or banks. If an NBFC relies heavily on bank borrowings, it faces a double impact. First, it has to allocate extra capital for lending in the unsecured category.
Second, the banks lending to them also need to set aside more capital, resulting in a higher cost of capital.
Many online lending apps focus on consumer loans, so the demand for such loans may decrease. This could lead to an increase in the Rate of Interest (ROI) for existing loans, impacting the creditworthiness of borrowers with higher debt-to-income ratios.
- How do the new RBI rules affect the number of loan defaults and the overall stability of the Indian economy?
Overdue payments for unsecured loans below ₹50,000 are already 5.4%. An increase in late payments in the unsecured retail segment has led regulators to take steps to ensure a stable economic environment in India compared to other countries. The late payment rate is expected to increase as more borrowers fail to repay while the rate for new loans decreases.
- Who will be the most hit?
Experts predict that SBI Card will face the biggest impact as it has the highest proportion of unsecured credit. Following closely are RBL Bank and Bajaj Finance. SBI Cards is already grappling with shrinking margins, reduced revolver rates, and elevated credit costs. The recent decision by the RBI is seen as an additional burden by industry experts.
Final Words
The RBI’s recent actions aim to address worries about the rapid growth of unsecured loans, prioritizing careful risk management to safeguard the financial system’s stability.
Happy investing and thank you for reading!
Disclaimer:
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