Retail credit, especially unsecured loans, has surged in recent years and the Reserve Bank of India has been concerned about it for some time. In his address post the monetary policy committee meeting in October, RBI Governor Shaktikanta Das had pointed that certain components of personal loans were recording very high growth and these were being closely monitored by the central bank for any signs of stress. Banks and non-banking finance companies were also urged to strengthen their internal surveillance mechanisms and address any build-up of risks.
On Thursday, the central bank tightened the screws on this credit binge by raising the risk weights on consumption loans, credit card exposures and loans to NBFCs by 25 percentage points each.
"As per extant instructions applicable to commercial banks, consumer credit attracts a risk weight of 100 per cent. On a review, it has been decided to increase the risk weights with respect to consumer credit exposure of commercial banks (outstanding as well as new), including personal loans, but excluding housing loans, education loans, vehicle loans and loans secured by gold and gold jewellery, by 25 percentage points to 125 per cent," RBI said in a notification.
It was also decided that retail loans given by NBFCs, excluding housing loans, education loans, vehicle loans, loans against gold jewellery and micro-finance loans, would attract a risk weight of 125 per cent instead of 100 per cent.
Risk weights on credit card receivables of scheduled commercial banks and NBFCs were also raised by 25 percentage points to 150 per cent and 125 per cent respectively. Separately, the risk weights on exposure of commercial banks to NBFCs was also increased by 25 percentage points.
Furthermore, RBI said that registered entities would have to review their extant sectoral exposure limits for consumer credit and put in place board-approved limits in respect of various sub-segments under consumer credit, as may be considered necessary by the board as part of prudent risk management.
Essentially, what the RBI move does is banks and NBFCs will have to back retail loans with additional capital. More capital will also have to be set aside by banks for loans to NBFCs. The cost of funds of NBFCs will also go up. Most banks are well-capitalised, but, some may have to raise further capital to meet these additional requirements.
The Reserve Bank's action doesn't come as a surprise for market watchers.
"Growth in unsecured retail loans and loans to NBFCs have exhibited a two-year compounded annual growth rate of 24 per cent/26 per cent respectively versus sector loan CAGR of 16 per cent over the same period. This pace of growth could have prompted the changes in risk weight by the central bank as a prudent measure even while asset quality trends have so far been holding up," said Shibani Kurian - senior executive vice-president and head of equity research, Kotak Mutual Fund.
According to Suman Chowdhury, chief economist and head of research at Acuite Ratings, apart from "moderation in the aggregate growth of unsecured loans" the measures will impact in several other ways.
"There could be a material increase in the rates charged on unsecured loans by banks and NBFCs. Higher cost of borrowings for large and small NBFCs (including Fintechs) with a high proportion of unsecured retail loans in their assets under management," he said.
Chowdhury further pointed that there will be higher mobilisation of capital by NBFCs into unsecured lending to cater to the additional capital requirements. “NBFCs could now focus on diversifying their fundraising from banks and there could be higher issuances in both public and private bond markets with attractive yields,” he added.
Mahrukh Adajania of Nuvama Institutional Equities said channel checks and RBI's financial stability report suggested that public sector banks, other than State Bank of India, had high non-performing assets on unsecured loans even with small exposures. So, while this move by the RBI was negative for the entire sector, it was necessary, he said.
"Entire sector is affected as it takes away the growth multiple. Banks relatively low on capital or with high exposures are more impacted," pointed Adajania.
Among the banks that would be most impacted by the move, he feels would be Axis Bank (rapid growth in unsecured lending, high share of NBFCs), SBI (low capital, though NPAs in control in unsecured loans), Kotak Mahindra Bank (large portion of incremental growth driven by unsecured loans), RBL Bank (high credit cards share) and Bank of Baroda (high NBFC loan share), apart from other PSU banks that have high exposure to NBFCs and high personal loan NPAs.
Sameer Bhise, Analyst at JM Financial Institutional Securities said as per initial calculations, there could be a potential impact of 70-80 basis points on CET1 (common equity tier 1) capital ratios of larger banks. Cost of funds is likely to inch up for most larger NBFCs by 10-20 bps as banks will pass on the higher capital charge to NBFCs.
"We expect growth rates for unsecured lending to moderate given regulator's relative discomfort towards these products, which could lead to newer entrants, smaller players actually reducing aggression. This will help large incumbents with solid capital base and longstanding track record though with a more calibrated stance," said Bhise.
Most banking stocks fell on Friday in the backdrop of this development. While SBI, IDFC First Bank, and Axis Bank were down more than 3 per cent in afternoon trade, ICICI Bank, Bank of Baroda, Federal Bank and Canara Bank declined around 1 per cent or more. HDFC Bank and Kotak Bank were also trading lower. RBL Bank was down around 7 per cent and SBI Cards slumped over 5 per cent.
Fintech Paytm also declined close to 2 per cent with analysts warning that increased capital requirement for its lending partners could hurt profitability in personal loans.
Shares of NBFCs like Aditya Birla Capital, Bajaj Finance, Piramal Enterprises, Ujjivan Financers, L&T Finance and Satin Creditcare also tumbled 2 per cent to 6 per cent.
"Our estimates suggest a 30-85 bps impact on capital ratios on account of the increase in risk weight. SBI Cards remains the most vulnerable with a 416 bps impact," said analysts at Motilal Oswal Financial Services.
The analysts added that strong profitability and healthy capitalisation levels across lenders should cushion the impact of this measure.
"In second quarter results, most lenders suggested that they have tightened the underwriting standards and are closely monitoring the risks in the retail segment. However, we remain watchful of growth and asset quality trends in unsecured retail," the Motilal Oswal analysts said.
As the economy has emerged post-COVID-19 pandemic, consumer loans have grown at a fast pace, well ahead of the overall loan growth. Post this move by RBI to raise risk weights, a moderation in consumer credit across the banking and finance industry is likely to be seen. A short-term decline in growth for high-ticket consumer products that was fuelled by such consumer loans is also a possibility.