Reserve Bank of India has made a significant regulatory adjustment that RBI reinstates risk weights on bank loans given to non-banking financial institutions (NBFCs) to 100% from the previously stipulated 125%. The shift will be effective from April 1, 2025. The step is likely to help banks and NBFCs by lowering capital requirements and enhancing credit flow, analysts said. Microfinance loans extended by banks have also been exempted from the increased risk weight, giving relief to lenders with high microfinance exposure.
Background: RBI Reinstates Risk Decision
In November 2023, the RBI raised the risk weight on consumer credit, such as personal loans and bank credit to NBFCs, from 100% to 125%. The step was taken to check the excessive growth of credit in the unsecured lending segment and reduce financial risks. But following a re-evaluation of market conditions, the central bank has now decided to reverse the increased risk weights to their earlier level.
This choice will affect primarily banks with heavy exposure to NBFCs because it will relieve them of funds for lending. It will enhance the liquidity levels of NBFCs so that they can borrow more cheaply, especially in a scenario where there are anticipated rate cuts.
RBI Reinstates Risk Impact on Banks: Capital Ratios to Improve
Experts have applauded the RBI action, saying it will enhance the capital adequacy ratios of banks. Bank of Baroda will see its Common Equity Tier 1 (CET-1) ratio rise by more than 45 basis points, while Federal Bank and Punjab National Bank (PNB) will benefit by between 35 and 40 basis points. State Bank of India (SBI), HDFC Bank, and Kotak Mahindra Bank are likely to improve by about 30 basis points.
Concurrently, ICICI Bank, AU Small Finance Bank, and IndusInd Bank are expected to gain 20 basis points, with Axis Bank and RBL Bank gaining less than 20 basis points. This capital ratio strengthening will improve the ability of these banks to lend, thereby becoming more resistant to financial shocks.
RBI Reinstates Risk: Relief for Banks Exposing High Microfinance Exposure
The RBI’s move to exclude microfinance loans from higher risk weights will come as a relief to banks having high exposure in this segment. Banks like Bandhan Bank, IDFC First Bank, IndusInd Bank, and RBL Bank had already borne negative capital effects with the 125% risk weight imposition.
Bandhan Bank witnessed a capital shock of 360 basis points, whereas IDFC First Bank, IndusInd Bank, and RBL Bank faced negative impacts of 100, 75, and 45 basis points, respectively. With the exception of microfinance loans, these banks will witness partial reversing of such adverse effects and be more resilient in the market of lending.
NBFCs to Gain from Decreased Borrowing Costs
The move is also good news for NBFCs, which depend largely on bank finance. With risk weights restored to 100%, NBFCs will be able to negotiate cheaper borrowing rates, lowering their cost of funds. This will be especially beneficial in a likely rate-cut scenario, where the cost of funds is likely to come down further.
NBFCs such as Mahindra & Mahindra Finance, Cholamandalam Investment, Bajaj Finance, and Shriram Finance stand to benefit significantly from this move. Lower funding costs will allow these NBFCs to pass on interest rate reductions to their customers, improving loan affordability and boosting demand for credit.
Brokerage Firms’ Outlook on the Policy Change
Citi’s Perspective
Citi’s analysts are of the view that the RBI action will bring short-term capital comfort to banks and enhance liquidity situations. The step will increase the lending ability of large banks and help NBFCs that take bank funding. Citi is especially bullish about stocks like Bank of Baroda, Federal Bank, and PNB due to their potential capital appreciation.
Morgan Stanley’s Take
Morgan Stanley pointed out that reversal of the risk weight hike will make the cost of and access to credit for borrowers easier. The brokerage sees investor sentiment in the NBFC space strengthening, which should result in better returns for these firms in the long run. Among NBFCs, Morgan Stanley’s top investment choices are PNB Housing, Shriram Housing, and Bajaj Finance.
Nomura’s Assessment
Nomura analysts also think the action will enhance bank credit flow to NBFCs, enhancing financial intermediation in the economy. They anticipate the largest gainers to be highly microfinance-expose banks like Bandhan Bank, IndusInd Bank, and AU Small Finance Bank. Although Nomura has a “reduce” call on AU Small Finance Bank, it has a “neutral” call on Bandhan Bank and IndusInd Bank.
RBI Reinstates Risk: What’s Next for the Banking and NBFC Sector?
With the RBI rollback coming into effect in April 2025, banks and NBFCs have a window of time to rework their portfolios and lending strategy. With the cost of borrowing for NBFCs reducing, they can pass on these savings to borrowers, resulting in higher credit demand. Banks will also have more flexibility in lending to NBFCs, enhancing financial liquidity in the system.
The rollback could also signal the RBI’s comfort with the current state of unsecured lending in the economy. While the November 2023 risk weight hike was aimed at controlling excessive credit growth, the reversal suggests a stabilization in lending patterns.
FAQs on RBI Reinstates Risk
1. What does the RBI’s rollback on risk weights mean?
The RBI has lowered the risk weight on bank loans to NBFCs from 125% to 100% with effect from April 1, 2025. This will lower banks’ capital requirements and decrease borrowing costs for NBFCs.
2. How will this affect banks?
The rollback will increase capital adequacy ratios, especially for banks with high exposure to NBFC lending. It will also enhance liquidity conditions, allowing banks to provide more credit.
3. Which banks will gain the most?
Banks like Bank of Baroda, Federal Bank, PNB, SBI, HDFC Bank, and Kotak Mahindra Bank will experience better capital ratios. Those with significant microfinance exposure, such as Bandhan Bank and IndusInd Bank, will also gain.
4. How will this affect NBFCs?
NBFCs such as Bajaj Finance, Mahindra & Mahindra Finance, Cholamandalam, and Shriram Finance will gain from reduced borrowing costs. This may result in enhanced profitability and enhanced loan affordability for customers.
5. What is the implication for microfinance lenders?
Microfinance loans have been exempted by the RBI from increased risk weights, giving relief to banks that have high microfinance exposure, including Bandhan Bank, IDFC First Bank, and IndusInd Bank.
The RBI move is likely to stimulate the banking and NBFC industry, enhancing liquidity and lending conditions in India’s financial markets. As the April 2025 deadline nears, investors and industry players will keep a close watch on further developments in the sector.
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