RBI’s Risk Weight Hike: Implications for Incremental Bank Lending to NBFCs

The Reserve Bank of India (RBI) recently implemented a significant increase in risk weight for bank exposures to Non-Banking Financial Companies (NBFCs). This move is expected to have a notable impact on incremental bank lending to the NBFC sector. In this article, we will explore the implications of the RBI’s decision and discuss the potential consequences for the lending landscape.

Key Points:

Decrease in Bank Loans to NBFCs:
As of January 2024, outstanding bank loans to NBFCs stood at Rs 15.03 trillion. However, in FY23, banks extended only Rs 3.08 trillion to finance companies, a significant decline compared to the previous year’s Rs 73,831 crore. This downward trend can be attributed to various factors, including the tightening of risk weights by the RBI.

Projections for FY25:
Rating agency ICRA estimates that direct bank lending to NBFCs in the upcoming financial year (FY25) will range between Rs 1.7 trillion to Rs 1.9 trillion. This projection indicates a moderation in bank credit to the NBFC sector. The increase in risk weights, coupled with internal sectoral limits, is expected to limit the availability of credit to NBFCs.

Regulatory Concerns and Risk Weights:

The RBI’s decision to raise risk weights by 25 percent, particularly for exposures below 100 percent, reflects regulatory concerns regarding the rapid pace of bank lending to NBFCs. By increasing risk weights, the RBI aims to mitigate potential risks associated with NBFC exposures and ensure prudential norms are followed by banks.

Impact on Funding Requirements:

The estimated incremental direct bank lending of Rs 1.7 trillion to Rs 1.9 trillion for FY25 is projected to meet approximately 33 percent of the total base case incremental funding requirements of the NBFC sector, which range from Rs 5.3 trillion to Rs 5.5 trillion. This marks a slight decrease from the previous year, where 38 percent of incremental funding requirements were met through direct lending.

Changing Dynamics and Credit Flow:

Over the past few years, private banks have increased their share in overall bank exposures to the NBFC sector. However, tighter liquidity conditions, intensified competition in deposit mobilization, and the need to improve credit-deposit (CD) ratios may impact private banks’ participation in the near term. This could subsequently affect credit flow to financial firms, including housing finance companies, unless public sector banks increase their exposures.

Conclusion:

The RBI’s increase in risk weights for bank exposures to NBFCs is expected to have a significant impact on incremental bank lending to the sector. The moderation in credit flow and the potential constraints faced by NBFCs in accessing funds highlight the need for careful monitoring and management of risks in the financial system. It remains to be seen how the lending landscape evolves in the coming years and how NBFCs adapt to the changing regulatory environment.

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