The Reserve Bank of India’s (RBI) recent decision to lower risk weights on commercial banks’ loans is expected to have only a modest positive effect on banks’ capital ratios, according to a CreditSights report published on February 26.
Modest Gains for Banks
CreditSights noted that the primary benefit for commercial banks will come from the reduced risk weights on loans to well-rated Non-Banking Financial Companies (NBFCs). However, the impact will remain limited since many commercial banks have relatively low exposure to microfinance loans.
For instance, Axis Bank and HDFC Bank—two of India’s leading lenders—each have microfinance loan exposures of less than 1% of their overall loan portfolio, according to the report.
RBI Reverses 2023 Decision
On February 28, the RBI restored lower risk weights for commercial banks’ loans to better-rated NBFCs and microfinance institutions. This move reverses the RBI’s November 2023 decision, which had increased the risk weight on loans to NBFCs by 25 percentage points (ppt) for those previously carrying a risk weight below 100%.
Additionally, in November 2023, the RBI had raised risk weights on all consumer credit loans from banks and NBFCs by 25 ppt to 125%. With the latest revision, the risk weight on microfinance loans will now revert to 100% for commercial banks.
Impact on Lending and Liquidity
CreditSights views the RBI’s adjustment as a strategic response to the slowdown in bank credit to NBFCs, which had been caused by a tight liquidity environment and weakness in unsecured retail lending, including credit cards and personal loans.
“We expect this change to enhance credit flow from banks to better-rated NBFCs and, in turn, to retail and underserved segments,” the report added.
The move is expected to support credit growth in key lending sectors while ensuring financial stability in India’s banking system.