RBI Tightens Norms, Elevates Credit Risk Weight For Unsecured Loans

The Reserve Bank of India (RBI) on Thursday raised risk weights on consumption loans, credit card exposures and loans to scheduled commercial banks(SCBs) and non-banking financial companies(NBFCs) by 25 per cent each. The action came after reviewing the lending pattern for several months and spending sufficient time to acclimatise lenders against the persistent credit surge. 

The reason behind this step is that the RBI hopes higher consumption of capital will slow down such rapid growth of unsecured lending. Since this increases the capital consumption of lenders, the borrowers of such loans would have to shell out more funds.

Personal loans at some of India’s largest private lenders are available at interest rates ranging from 10.5 per cent to 25 per cent for salaried employees, according to their official websites.

"The immediate impact of the enhanced risk weights is the excess capital now that banks would require. As per our calculation, the banking industry need Rs 84,000 crore of excess capital due to these regulatory measures," SBI ecowrap report pointed out.

"Over the last few years, retail loans have come to be the key driver of overall credit growth – clocking around 16.5 per cent compound annual growth rate (CAGR) between FY19 to FY23, as against 12.1 per cent CAGR for nonfood credit for the same period. Within retail, unsecured loans (other personal loans and credit card loans) have grown at a faster clip, while secured home loans have grown at a slightly slower pace," ICICI securities highlighted in its report.

The share of unsecured loans (in overall retail loans) has been progressively growing with a minor blip pushing the figure down during the initial phase of the pandemic to 29.7 per cent in FY21 as against 31.7 per cent in FY20.

"Post-pandemic, unsecured loans have resumed their rising trajectory – share advancing to 32.2 per cent (of overall retail) as of FY23 and further to 32.7 per cent as of August 2023. As compared to overall loans, unsecured retail loans share has risen to around 10 per cent as of August 2023 versus 8.1 per cent as of FY19," ICICI report mentioned.

Unlike corporate loans, despite being hurt by the pandemic, Gross non-performing assets(GNPA) in the retail segment have been consistently range-bound. This is in part due to timely and prudential write-offs practiced by the banks in the current cycle. Due to covid-19 headwinds, GNPA levels increased from 1.8 per cent in FY19 to 2.1 per cent for FY21.

“Credit offtake continued to grow, increasing by 19.3 per cent year on year (YoY) to reach Rs 153.4 lakh crore for the fortnight ending 6 October 2023,” CareEdge report states.

This surge continues to be primarily driven by the impact of HDFC’s merger with HDFC Bank and growth in personal loans.

“Meanwhile, if the impact of the merger is excluded, credit grew at a lower rate of 14.7 per cent YoY fortnight compared to last year. The outlook for bank credit offtake remains positive, with a projected growth of 13 to 13.5 per cent for FY24, excluding the merger's impact,” the  CareEdge report added.

The Credit to deposit (CD) ratio has been generally hovering above 75 per cent since December 2022. The CD ratio saw a downtick of 35 basis points (bps), compared to the previous fortnight and stood at 78.3 per cent on a fortnight basis.

“In absolute terms, over the last twelve months, credit offtake has expanded by Rs 24.8 lakh crore to reach Rs 151.5 lakh crore as of 6 October 2023,” the CareEdge report highlights.

Despite having an increase in deposits, there has been a significant rise in unsecured loans. "The increase in the unsecured loan has risen significantly after Covid-19,” stated a report by SBI.

There has been a rise of about 250 basis points in unsecured loans from January 2019 to August 2023. “The share of unsecured loans was 7.5 per cent which has increased to more than 10 per cent till August 2023,” the report added.

Cibil CMI data suggests that as of March 2023, personal loans of Rs 50,000 and more comprise 98 per cent of the total personal loan book size in terms of value. Small ticket personal loans of less than Rs 50,000 form approximately 2 per cent of the personal loan book size (in terms of value) and account for only 0.3 per cent of the total retail loan book size at the industry level.

“Household debt as measured by credit card outstanding per credit card in India has been either static or declining both in nominal and real terms (after adjusted for CPI inflation) in 2023,” SBI stated in its report.

In nominal terms, the outstanding per credit card rose by 13 per cent in August which was down by 24 in January. “The real outstanding per credit card growth in August declined to 5.8 from 16.4 in January,” the report mentioned.

Time trend in retail loans shows no major compositional shifts since April 2021 for secured as also unsecured portfolio of retail credit with both secured and unsecured segments growing since Covid-19. Also, the share of secured portfolio dominates the unsecured portfolio within retail space.

“Total share of unsecured retail loans is only around one-tenth of all scheduled commercial banks(ASCBs) credit portfolio,” SBI stated in its report.

Macquarie has highlighted in the report that HDFC Bank and SBI Cards & Payment Services are among the most impacted entities in terms of contraction in common equity tier one (CET-1) ratios. 

RBI flagged the high growth in certain segments of consumer credit and advised scheduled banks(SCBs) and non-banking financial companies (NBFCs) to fortify their internal surveillance mechanisms.

This will help in addressing the build-up of risks and develop suitable safeguards. The high growth of consumer credit and increasing dependency of NBFCs on bank borrowings were also highlighted by the RBI Governor in July and August 2023, respectively.

The higher the perceived risk, the greater the risk weight assigned to a particular loan category.

What is risk weight of credit exposure?

Risk weight is the capital required that needs set aside, mandated as per the Reserve Bank of India for SCBs, NBFCs and housing finance companies (HFC), that has to be made by banks for giving the loan. 

In simple terms, it is the amount which is depicted as a percentage of loan disbursed that institutions need to mandatorily set aside for assets. The loan is an asset for the bank therefore the bank needs to set aside a certain percentage of the loan. 

The risk weight is dependent on the risk perception that the bank perceives on loans for different sectors. It applies to all categories of retail loans, personal loans, home loans, car loans, education loans and corporate lending.

So, for instance, for a home loan of over Rs 75 lakh, if the risk weight is 125 per cent. If a bank has a portfolio of Rs 1,000 crore of loans above Rs 75 lakh, the risk weight becomes Rs 1,250.

Higher risk weight inversely impacts the lending capacity of the banks. The capital adequacy ratio(CAR) also comes into play with the increase in risk weight.

“The debt-equity ratio as of 30 September 2023 was 1.4 times, amongst the lowest in the NBFC sector. The capital adequacy ratio was 42.2 per cent as of 30 September 2023,” Poonawalla Fincorp(PFL) said in a press statement. 

The diversified portfolio of pre-owned car finance, personal loans, loans to professionals, business loans, SME loans against property, supply chain finance, machinery loans, medical equipment loans and consumer loans decrease the risks.

“Based on our initial calculations, the increase in the risk weight from 100 per cent to 125 per cent on the company’s consumer credit exposure shall be marginal and is expected to be around 220 bps. With this, the resultant CAR would become around 40 per cent, still significantly higher than the regulatory requirement of 15 per cent. As per our long-term plans, we do not expect our debt equity to go beyond 4 times. Given our strong capital adequacy, either on an immediate basis or in the foreseeable future, we do not expect any impact of the increased risk weights on our growth trajectory and profitability,” PFL added in the statement.