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Risk Weight Revisions In Consumer Credit

By - Ajay Singh on December 8, 2023

Introduction:

Significant regulatory actions have been taken by the Reserve Bank of India (RBI) recently, with the goal of influencing the consumer credit market and expanding bank lending to Non-Banking Financial Companies (NBFCs). Ensuring responsible lending practices, preserving financial stability, and promoting a robust credit ecosystem all depend heavily on these rules. The benefits and ramifications of these recent RBI directives are examined vide Notification dated November 26, 2023- (RBI/2023-24/85).

Consumer Credit Regulations:

The RBI has been proactive in safeguarding the interests of consumers by implementing guidelines to regulate the consumer credit sector. This includes measures to enhance transparency, ensure fair practices, and protect consumers from predatory lending.

The aforementioned directives have been promulgated in the execution of the authority vested by Sections 21 and 35A of the Banking Regulation Act, 1949; Chapter IIIB of the Reserve Bank of India Act, 1934; and Sections 30A, 32, and 33 of the National Housing Bank Act, 1987

  • Consumer Credit Exposure of Commercial Banks:

In accordance with existing directives applicable to commercial banks, consumer credit currently carries a risk weight of 100%. Following a comprehensive review, it has been determined to augment the risk weights associated with consumer credit exposure for commercial banks, both outstanding and new. This includes personal loans, excluding housing loans, education loans, vehicle loans, and loans secured by gold and gold jewellery. The revised risk weight is set at 125%, marking a 25-percentage point increase.

  • Consumer Credit Exposure of NBFCs:

As per extant norms, NBFCs' loan exposures generally attract a risk weight of 100%. However, upon careful review, it has been decided that consumer credit exposure of NBFCs, categorized as retail loans shall now attract a risk weight of 125%.

  • Credit Card Receivables:

Under current instructions, credit card receivables for scheduled commercial banks (SCBs) carry a risk weight of 125%, while for NBFCs, the risk weight is 100%. Post-review, it has been determined to raise the risk weights for these exposures by 25 percentage points. Accordingly, SCBs and NBFCs will now bear risk weights of 150% and 125%, respectively.

  • Bank Credit to NBFCs:

Exposures of scheduled commercial banks (SCBs) to NBFCs, excluding core investment companies, are currently risk-weighted based on ratings from accredited external credit assessment institutions (ECAI). After a recent review, it has been resolved to increase the risk weights for SCBs by an additional 25 percentage points in cases where the existing risk weight, as per the external rating of NBFCs, is below 100%. This adjustment excludes loans to Housing Finance Companies (HFCs) and loans to NBFCs eligible for priority sector classification.

  • Strengthening Credit Standards:
    • Recognized Entities (REs) are mandated to conduct a thorough review of their existing sectoral exposure limits for consumer credit. Board-approved limits are to be established, where absent, for various sub-segments under consumer credit as deemed necessary by the Boards for prudent risk management. This includes prescribing limits for all unsecured consumer credit exposures. The Risk Management Committee is entrusted with the responsibility of strict adherence to these limits, with ongoing monitoring.
    • All top-up loans extended by REs against inherently depreciating movable assets, such as vehicles, are to be treated as unsecured loans for credit appraisal, prudential limits, and exposure purposes.

Advantages of Bank Credit Guidelines for NBFCs:

  1. Financial Stability: By enhancing liquidity support and imposing prudential norms, the RBI aims to fortify the financial stability of NBFCs. This is essential for preventing systemic risks and maintaining confidence in the financial markets.
  2. Improved Risk Management: The guidelines encourage banks to adopt robust risk management practices when extending credit to NBFCs. This ensures that banks are better equipped to assess and manage the risks associated with their exposure to the NBFC sector.

Exemption

Notwithstanding the aforementioned adjustments in risk weights for consumer credit exposure, it is hereby clarified that certain loan categories shall be exempt from the stipulated revisions. Specifically, home loans, vehicle loans, and loans secured by the mortgage of gold and gold jewellery shall be regarded as exceptions to the prescribed risk weight enhancements. Therefore, these loan types shall maintain their original risk weights as per extant instructions, and the revised percentages shall not be applicable to them. This exemption is in recognition of the unique risk profiles and collateralization features associated with home loans, vehicle loans, and loans secured by the mortgage of gold and gold jewellery.


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