RBI Reduces Risk Weights on Bank Financing to NBFCs and Microfinance Loans to Boost Lending Capacity

The Reserve Bank of India (RBI) has reduced risk weights for bank financing to Non-Banking Financial Companies (NBFCs) and microfinance loans. This change is expected to free up more funds and enhance credit availability. Lower risk weights mean banks can allocate fewer reserves for consumer loans, thus increasing their lending capacity.

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In November 2023, the RBI had increased the risk weight on commercial banks' exposure to NBFCs by 25 percentage points. This was above the existing risk weight based on external ratings when it was below 100%. The RBI has now decided to revert these risk weights to their previous levels, according to a circular issued by the central bank.

Impact on Microfinance Loans

The RBI also reviewed risk weights on microfinance loans. Previously, in November 2023, consumer credit risk weights, excluding housing, education, vehicle loans, and loans secured by gold, were raised to 125%. Now, microfinance loans considered consumer credit will not be subject to these higher risk weights and will have a 100% risk weight instead.

Microfinance loans that do not qualify as consumer credit but meet specific criteria may be classified under the regulatory retail portfolio (RRP). Banks must establish appropriate policies and procedures to ensure these criteria are met. Additionally, microfinance loans from regional rural banks (RRBs) and local area banks (LABs) will also have a 100% risk weight.

Sectoral Implications

According to MFIN data for the third quarter of the fiscal year, the microfinance portfolio decreased by 3.53% year-on-year, totaling Rs 3,85,348 crore. Anil Gupta from ICRA noted that this move is beneficial given the sector's current challenges. It should provide some relief and broaden credit access compared to recent times.

Anil Gupta further explained that due to a significant slowdown in bank credit to NBFCs this fiscal year and tighter market liquidity, prioritising credit flow to underserved segments is crucial for growth. The RBI's decision to restore lower risk weights aims to address these issues.

Benefits for NBFCs

A M Karthik from ICRA highlighted that restoring lower risk weights for better-rated NBFCs will enhance credit flow from banks to NBFCs. This change will immediately benefit their capital ratios. Improved credit flow to NBFCs is expected to boost overall retail segment credit flow, supporting economic growth.

This adjustment by the RBI is seen as a positive step towards easing financial constraints faced by NBFCs and microfinance institutions. By reducing risk weights, the central bank aims to stimulate lending activities and support broader economic development.