RBI tightens norms on consumer loans

The Reserve Bank of India (RBI) has announced a significant overhaul in its approach to consumer loans, aiming to mitigate potential risks in the financial sector and enhance stability.The central bank's decision involves tightening norms related to consumer lending and increasing the risk weight on credit exposure, signaling a more cautious stance towards lending practices.The Reserve Bank of India (RBI) increased risk weights on consumer loans from banks, non-banking finance companies (NBFCs) and credit card providers, making it more expensive for lenders across the spectrum to offer loans in these segments. That will mean higher interest rates for all borrowers.Furthermore, bank lending to NBFCs will also become more expensive as risk weights on these loans have also been raised beyond a specified threshold. The new risk weighting will apply to all existing loans in the consumer segment as well, potentially requiring banks to advance their capital-raising timelines as they need more money now as cover against risky exposure.Risk weights refer to the amount of capital lenders have to set aside to cover for credit risk from a particular loan segment. A higher risk weighting requires banks to set aside more capital for those loans.In its latest move, RBI increased the risk weight on consumer credit for banks and NBFCs to 125% from 100%. Under existing rules, banks must set aside Rs 8 for every Rs100 lent for personal loans. Now, they will need to keep aside 25% higher, or Rs10, on every Rs100 lent.

The new rules are not applicable to housing loans, education loans, vehicle loans and loans secured by gold and gold jewellery, the RBI said.Thursday's intervention follows repeated warnings from Governor Shaktikanta Das and his deputies over the past few months about rising credit risks in the system. An explosive growth in fintech firms and the increasing ability of lenders to reach hitherto unbanked customers have led to instant disbursal of loans - at times oblivious of the borrowers' ability to repay. Defaults have also been rising in the below-Rs 50,000 credit segment.
"Certain components of personal loans are recording very high growth," Das had said after the monetary policy committee's (MPC) last review meeting in October. "These are being closely monitored by the Reserve Bank for any signs of incipient stress. Banks and NBFCs would be well advised to strengthen their internal surveillance mechanisms and address the build-up of risks."
The Reserve Bank's decision to tighten norms for consumer credit by raising risk weight for unsecured personal loans is likely to hit banks' capital adequacy by 60 basis points, S&P Global Ratings said on November 17. "Slower loan growth and an increased emphasis on risk management will likely support asset quality in the Indian banking system. "However, the immediate effect will likely be higher interest rates for borrowers, slower loan growth for lenders reduced capital adequacy, and some hit on profits. We estimate that the Tier-1 capital adequacy of banks will decline by about 60 basis points. Finance companies will be worse affected as their incremental bank borrowing costs will surge, in addition to the capital adequacy impact," S&P Global Ratings credit analyst Geeta Chugh said in the statement.
The RBI's decision to tighten norms on consumer loans and increase the risk weight on credit exposure underscores its commitment to maintaining financial stability and safeguarding against potential systemic risks arising from excessive consumer debt. This move aligns with the ongoing efforts to ensure a balanced and sustainable growth trajectory for India's financial sector.

(Ira Singh, Asstt Editor)