Reserve Bank of India frees up bank capital with NBFC risk weight rollback

Following the increase in risk weights, bank loan growth to shadow banks fell sharply

With bank loan growth slowing over the past year, the Reserve Bank of India (RBI) has decided to reverse its decision to increase the risk weight of bank loans to non-banking financial companies (NBFCs), which will result in a substantial release of capital for banks. In addition, it clarified that risk weights for microloans by banks will be 75 per cent or 100 per cent, depending on the nature of the loan, rather than 125 per cent.

 

In a circular issued on Tuesday, the banking regulator said: “Upon review, it has been decided to restore the risk weights applicable to such exposures (NBFC exposure), and the same shall be in line with the external rating.” This comes into effect from April 1, 2025.

 

On November 16, 2023, risk weights for bank loans to NBFCs were increased by 25 percentage points — over and above the risk weight associated with the given external rating — in all cases where the existing risk weight, in accordance with the external rating of NBFCs, was below 100 per cent. This meant that bank loans to AAA-, AA-, and A-rated NBFCs — where the external risk weight was below 100 per cent — were increased by 25 percentage points.

 

Following the increase in risk weights, banks’ loan growth to shadow banks fell sharply.

 

According to RBI data, banks’ year-on-year loan growth to NBFCs dropped to 6.7 per cent by December 2024 from 15 per cent a year ago. Overall bank credit growth also slowed to 11.2 per cent from 20 per cent during the same period. 

 

“The restoration of lower risk weights for better-rated NBFCs will improve the credit flow from banks to NBFCs while being immediately beneficial for their capital ratios,” said Anil Gupta, senior vice-president, financial sector ratings, Icra.

 

Lower risk weights mean banks will have to set aside less capital for such loans.

 

“Lowering risk weights will free up banks’ capital. It is a positive move for the overall NBFC sector. Prior to November 2023, 47 per cent of NBFC borrowing was from banks. That has already declined to 45 per cent over the past year. NBFCs had to explore alternative sources like capital markets and external commercial borrowings (ECBs). At a time when dollar movement has been adverse for ECB hedging costs, alternative funding options for NBFCs were becoming limited,” said Ajit Velonie, senior director, Crisil Ratings.

 

In a major relief to banks with large microfinance portfolios, including many small finance banks, the RBI clarified that the risk weight for microloans will be 75 per cent for loans that fall into the category of regulatory retail portfolio or business loans.

 

Microloans that do not fall under regulatory retail and are classified as consumer credit will have a 100 per cent risk weight. Consumer credit refers to loans extended for consumption purposes. Previously, in both cases, banks’ risk weight was 125 per cent.

 

The November 2023 circular created confusion among banks about whether loans would attract higher risk weights, as there was no increase in risk weights for NBFCs’ microloans.

 

“Some banks were asked by their RBI supervisors to increase the risk weight, leading to differential treatment. That ambiguity has now been removed,” said a risk officer at a mid-sized commercial bank.

 

“It has been clearly stated that microfinance loans categorised as consumer credit will not have a 125 per cent risk weight but rather 100 per cent. And if the microfinance loan meets the criteria for regulatory retail, the risk weight will be 75 per cent,” added Velonie.