What is risk weight?

Risk weight is capital required to be set aside, stipulated by the Reserve Bank of India for banks, or National Housing Bank for housing finance companies, that has to be made by banks for giving the loan. In other words, it is the amount (depicted as percentage of loan disbursed) that institutions need to set aside for assets.

The risk weight is a function of the risk perception the apex bank has on loans for different sectors. It is applicable to all categories of retail (personal, home, car and education loans) as well as corporate lending. The one that often impact borrowers directly, and the most, is the risk weight on home loans.

What are the risk weights on loan currently?
For unsecured loans such as personal loans and credit cards, the risk weight is high and fixed at 125 per cent. For secured loans, like home loans, it depends on the amount of loan taken and the loan-to-value (LTV) ratio.

For home loans of less than Rs 30 lakh and a loan-to-value (LTV) ratio of less than 75 per cent, the risk weight is 50 per cent for amounts. For loans between Rs 30 lakh-Rs 75 lakh, it stands at 75 per cent. For those above Rs 75 lakh, it is 125 per cent

How is it done?
The bank or housing finance company has to keep aside money, based on the risk weight. So, for instance, for a home loan of over Rs 75 lakh, 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.

Now the capital adequacy comes into play. While it is nine per cent for banks, for housing finance companies it stands at 12 per cent. In simple terms, it means a bank would need to set aside Rs 112.50 crore, and a housing finance company, Rs 150 crore.

How does it impact borrowers?
Home loan borrowers and the real estate sector, especially, have suffered the wrath of the apex bank. RBI has been uncomfortable with the consistent rise in the property rate. As a result, it has raised risk weights to this sector.

A higher risk implies the bank will have to set aside a higher amount as loan provisioning. As a result, banks could be averse or less enthusiastic to lend to a particular sector. The rack rates on offer for loans also become higher.