India’s restored risk weights offer modest impact to banks

The move will enhance flow of credit from banks to better-rated NBFCs.

The Indian central bank’s decision to lower risk weights on commercial banks’ loans will have a “modest” positive impact on the banks’ capital ratios, according to CreditSights.

“We anticipate a modest positive impact on commercial banks’ capital ratios, primarily from the reduced risk weights on exposures to better-rated NBFCs, as the commercial banks we cover generally have relatively minor exposure to microfinance loans,” CreditSights said in a 26 February report.

CreditSights added that Axis Bank and HDFC Bank’s exposures to microfinance loans are less than 1% of their overall loans.

On February 28, the Reserve Bank of India (RBI) announced the restoration of lower risk weights on commercial banks’ loans to better-rated non-banking finance companies (NBFCs), and banks to microfinance loans.

This reverses the November 2023 decision to increase the risk weight on commercial banks’ loans to NBFCs by 25 percentage points (ppt) for cases where the risk weight was below 100 percent.

The RBI has also raised the risk weight on all consumer credit exposures of commercial banks and NBFCs by 25 percentage points (ppt) to 125% in November 2023. This risk weight will revert back to 100% for commercial banks’ loans to the microfinance segment.

“We view the RBI's adjustment as a rational response to the significant slowdown in bank credit to NBFCs amid a tight liquidity environment, and ongoing weakness in the unsecured retail segment (cards and personal loans) which has also spread into microfinance,” CreditSights said.

“[We] expect this change to enhance the flow of credit from banks to better-rated NBFCs (and in turn to retail) and underserved segments,” it added.