Bandhan Bank, Ujjivan Small Finance Bank major beneficiaries of RBI move

The Reserve Bank of India (RBI) decided to make a significant policy reversal, by rolling back the excess 25 per cent risk weights on the exposures of banks to non-banking financial companies or NBFCs, as well as Micro-Finance Institutions (MFI) which had been raised in November 2023. This reduction will support growth and improve CET-1 (Common Equity tier 1) for banks.

 

The November 2023 decision had stressed capital adequacy ratios, creating challenges for banks. The reduction to pre-Nov’23 levels will alleviate pressure, in a scenario where profitability of many mid-sized banks is under pressure due to quality concerns about unsecured assets.

 

Banks may see an improvement in CET-1 ratios, as they will require less capital to make such loans. This will enhance the ability to absorb potential shocks to asset quality.

 

The reversal in risk weights on MFI loans from 125 per cent to 100 per cent and 75 per cent will help reduce risk weighted assets or RWAs for banks. Universal banks like Bandhan Bank, IndusInd Bank, RBL Bank, IDFC First Bank among others with significant exposure to the MFI sector will be key beneficiaries. This may support return on equity or RoE and reduce the need to raise capital, at least in the short term.

 

While the reduction in risk weights may not be a significant incentive to lend to NBFCs —many banks are struggling with elevated credit-deposit ratios, asset quality issues— the intent and the timing of the reduction sends an important signal. It highlights the central bank’s preferences towards credit growth and encourages lenders.

 

Over the past nine months, the MFI industry loan book had declined 11 per cent year-to-date, while bank loans to NBFCs have seen a decline in growth to 6.6 per cent Y-o-Y (Dec’25) vs 30 per cent Y-o-Y growth in FY23 and 16 per cent Y-o-Y growth in FY24. There could be a recovery of growth in both segments.

 

This is one of several encouraging measures taken recently to support the sector. These include a reduction in the repo rate, undertaking of liquidity-enhancing operations, deferment of LCR, ECL, and project-financing regulations, and the lifting of supervisory restrictions on Kotak Mahindra and others. This is at a time of asset quality stress, with MFI lenders, in particular, likely to face elevated provisions in Q4FY25. It may specifically trigger more stimulus to the rural and semi-rural economy. The reduction in risk weights may lead to banks passing on lower lending rates to NBFCs, (apart from the impact of the recent repo cut). 

 

Key criteria include MFI loans to individuals or small business owners, loan exposure of less than Rs 7.5 crore, and loan repayments in the form of EMI versus bullet payments. Banks may choose to categorise MFI loans under RRP (Reverse Repurchase), and charge a risk weight of 75 per cent even though the classification will be periodically reviewed by RBI and over-aggressive categorisation could see the regulator taking action. However, existing loan portfolio with 125 per cent weight will see major relief. Some analysts assess the measure may improve tier-I capital for banks and small finance banks by between 7-485 basis points, with Ujjivan Small Finance Bank and Bandhan Bank the biggest beneficiaries. RBL and IDFC will also witness relief as they are operating at a sub-optimal tier-I ratio of below 14 per cent.

 

However, given known asset quality issues following the imposition of MFI guardrails, banks are likely to be somewhat conservative in chasing growth. In the long run, assuming no worsening of asset quality- reduced risk weights should revive growth to this segment which is high-yield.