Context:
The Reserve Bank of India (RBI) has reversed its previous decision to increase risk weights on bank loans to Non Banking Financial Companies (NBFCs), starting from April 1, 2025. This move should boost credit flow to NBFCs and release sizable capital for banks.
Background: The Initial Risk Weight Increase
- November 16, 2023
- RBI increased the risk weights on NBFC loans by 25 percentage points, where those risk weights already existing (based on external ratings) were below 100%.
- This affected AAA , AA , and A rated NBFCs, thereby rendering banks’ loans against these entities more capital intensive.
Why the Reversal?
- Slower growth in bank lending
- Bank loan to NBFCs: growth of 6.7% (YoY) by December 2024, down from 15% a year ago;
- Overall bank credit growth that halved, from 20% to 11.2% during the same period.
- The higher risk weights discouraged banks to lend to NBFCs, which exacerbated liquidity conditions of the NBFC sector.
New Risk Weight Structure
- Risk weights for loans to Non Banking Financial Companies will continue as before aligned to external ratings.
- Regulatory Authority of India termed Risk Weight of 75-100% for Microloans instead of 125%.
Implications and Benefits
- Differentializing Bank Funding to NBFCs Eases External Credit Flow to Shadow Banks for Liquidity Support.
- Relief in Capital for Banks Loss of Lower Allocation Requirement Improves Capital Adequacy.
- Found Benefit for Growth Support of NBFCs Easier Availability of Funds in Lending and Business Operations.
- A Possible Rebounding Overall Credit Growth that would Alleviate the Recent Slowdown in Lending by Banks.
