With the aim of bolstering the financial sector's resilience, the Reserve Bank of India (RBI) on November 16 enforced a 25 per cent increase in risk weights on consumer credit exposure for commercial banks and non-banking finance companies (NBFCs). This adjustment applies to both existing and new credit, specifically targeting personal loans while excluding housing loans, education loans, vehicle loans, and loans secured by gold.
Despite the routine nature of such policy adjustments, the markets displayed an unwarranted tendency to overanalyse and overreact. During the October monetary policy, RBI Governor Shaktikanta Das had forewarned of the escalating growth in specific components of consumer credit.
The subsequent augmentation in risk weights is a calculated response, acting as a shield against the imprudent surge in consumer credit. The regulator's prudent concern extends to the surge in unsecured lending and consumption-based loans, addressing potential systemic risks associated with an unchecked proliferation of unsecured loans. Elevated levels of unsecured lending pose a heightened risk of default, potentially leading to repercussions on Non-Performing Assets (NPAs) for banks and NBFCs. The regulator's vigilance reflects a commitment to maintaining financial stability, aligning with its broader mandate to ensure the resilience of the financial system against vulnerabilities arising from excessive reliance on unsecured credit.
This regulatory intervention holds significant implications for both the oversight framework and the consumer lending sector. The NBFCs and fintech entities are compelled to undergo a strategic review of their operational models, and capital structures. The anticipated upswing in interest rates, propelled by an augmentation in risk weights, has the potential to escalate borrowing costs for consumers, and amplify loan rejection rates. The reduction in Capital Adequacy Ratios (CARs) poses a capitalisation hurdle, urging financial entities to explore avenues for capital infusion.
Fintech firms lacking autonomous balance sheets or co-lending capabilities encounter vulnerabilities, necessitating alternative sources of capital and debt for onward lending. The implicit directive to institute a hard-coded limit for unsecured consumer credit introduces a board-level governance layer, aligning with the RBI's commitment to instil prudential risk management and ensure a methodical approach to consumer lending.
Speculative reactions in the markets underscore a fundamental issue — the shallowness of debt markets and the complacency within banks’ business models. The tendency to inflate the significance of routine policy adjustments reflects a lack of depth in understanding the intricacies of financial regulations. The regulator's primary objective is the fortification of the financial sector, transcending short-term market fluctuations.
Emphasising the health of balance sheets and the NPAs reveals a strategic prioritisation grounded in the fundamental principles of financial stability. The regulator's vigilance echoes a commitment to fortify the financial pillars before extending its purview to the broader consumption economy, seeking a delicate balance between credit growth facilitation and risk mitigation.
In essence, the RBI’s role as a proactive guardian signals a commitment to long-term financial well-being, utilising routine policy tools to address emerging risks, and maintain the overall health of regulated entities. Markets should recognise these measures as part of the norm, refraining from overreaction and acknowledging the regulator's calculated steps to pre-emptively manage potential risks. Such policy manoeuvres are intrinsic to the regulatory framework. It's a reminder that this is as normal as financial governance can be.
(Srinath Sridharan is an author, policy researcher and corporate adviser. X: @ssmumbai.)
Disclaimer: The views mentioned above are the author's own. They do not necessarily reflect the views of DH.