Regulatory Measures Towards Consumer Credit And Bank Credit To NBFCS

The Reserve Bank of India released a notification on the 16^th of November, 2023, directing Banks and Non-Banking Financial Companies (NBFCs) to increase risk weights in order to mitigate the risks they may face through money-lending. It has issued these regulatory measures in light of the rapid growth in retail loans and bank lending to NBFCs. It was a much-needed intervention which was done in order to direct lending entities adapt to the changes in the market. The intent behind this is to address ‘credit risk’, which refers to the risk of a borrower not being able to meet their credit obligations or defaulting on commitments. These risks are managed by banks with the help of ‘risk weights’, which adjust for the risk associated with a particular asset type. Essentially, it indicates the holding that a lender must ideally possess in order to adjust the associated risk. It promotes return maximization for banks by maintaining their credit risk exposures within reasonable parameters.

The notification has been divided into 3 parts, each addressing various relevant facets which will allow banks to mitigate the aforementioned risks, namely, A. Consumer Credit Exposure, B. Bank Credits to NBFCs  and C. Strengthening of Credit Standards. Firstly, with regards to Consumer Credit Exposure, the RBI has directed that the risk weight in relation to commercial banks, which is already at 100%, to be increased by 25 percentage points, to 125%. This is to be done in respect of all loans including personal loans, but excludes housing loans, education loans, vehicle loans and loans secured by gold and gold jewellery. As for Consumer Credit Exposure in relation to NBFCs, the risk weight is directed to be increased by 25% well, bringing the total from 100% to 125%. This is to be done in respect of retail loans excluding housing loans, educational loans, vehicle loans, loans against gold jewellery and microfinance/SHG loans. Furthermore, risk weight in relation to Credit Card Receivables of Scheduled Commercial Banks (SBCs) are subject to an increase of 25% as well, raising the overall weight from 125% to 150%. However, the Credit Card Receivables from NBFCs have also received a 25% increase, bringing it from 100% to 125%.

Exposures of Scheduled Commercial Banks to NBFCs are risk weighted in accordance with the ratings which External Credit Assessment Institutions (ECAI) formulate. NBFCs, excluding core investment companies, which have an assigned risk weightage less than 100% are subjected to an increase of 25%. However, loans to HFCs, and loans to NBFCs which are eligible for classification as priority sector are excluded.

The RBI has also issued directions to strengthen credit standards to Regulated Entities. It has asked REs to review their existing sectoral exposure limits for consumer credit and to evaluate limits upon various sub-categories of consumer credit as seen fit by the Board of these entities, only if not performed already. The RBI has also stressed on limits being prescribed for all unsecured consumer credit exposures and that these limits be monitored on an ongoing basis by a Risk Management Committee. Furthermore, it has also directed that all top-up loans extended by REs against movable assets which are inherently depreciating in nature to be treated as unsecured loans for prudential limits, exposure purposes and credit appraisal.

Even though the immediate impact of these directions would slow down the rate of lending, in the long run, it will bode very well for the market as potential damage could be mitigated. The increased risk-weights lead to a domino effect, in that the lending rates provided, and funding costs will see a marginal increase. Hence, NBFCs will be required to scale down businesses along with several other adjustments besides those mentioned above, in order to adapt to the new regulatory framework.