Finally, the RBI has initiated tightening of screws on reckless retail uncollateralized lending by banks and NBFCs by increasing the risk weight on such loan portfolios. (see the notification here)
Including the outstanding and incremental loans, the risk weights in respect of consumer credit exposure of banks, higher risk weight has been increased by 25pp to 125% for personal loans excluding housing loans, education loans, vehicle loans, and loans secured by gold and gold jewellery. The same hike in risk weight to 125% is applicable to retail lending by NBFCs.
On credit card receivables the risk weights for Banks (currently at 125%) and NBFC (100%) have been hiked to 150% and 125%, respectively.
Risk weights on bank lending to NBFCs have been increased by 25pp (over and above the risk weight associated with the given external credit rating) in all cases where the extant risk weight of NBFCs is below 100%. Loans to HFCs, and loans to NBFCs that are eligible for classification as priority sector shall be excluded.
In addition, the RBI has directed to put in place Board-approved limits in respect of various sub-segments under consumer credit. In particular, limits shall be prescribed for all unsecured consumer credit exposures. The limits so fixed shall be strictly adhered to and monitored on an ongoing basis by the Risk Management Committee.
Additionally, top-up loans against movable assets (eg vehicles) shall be treated as non-collateral loans.
All in all, the complacency of lenders with respect to a potential surge in delinquencies, where households are funding ordinary consumption using retail loans and possibly being used for trading in the financial markets may be bothering the RBI as they pose a systemic risk for financial stability.
As we have emphasized numerously, those concerns are germane as retail lending/total bank loan (32%) has reached a max level since 1990, and non-mortgage/retail lending has also climbed up to 52%.
We have also highlighted the risk of delinquency due to leverage consumption amid faltering real per capita income growth of households (HH), which has decelerated to 1.8% on 4-year CAGR in FY23, i.e. lowest since 1982.
Given that these risks were visible over the past several quarters, as highlighted by our notes and precautionary notes from CIBIL, RBI’s restrictive response exemplifies a delayed action. The fact that it has been announced amid elections in several major states and ahead of general elections is indicative of a deeper malaise, that requires immediate restrictive regulatory response.
The implications of the RBI’s retail credit tightening measures are both by way of signalling and actual impact.
- The central bank wants to restrain the exuberant credit lending by both banks and NBFCs. The high-risk weight would imply curbing capital leverage for banks and NBFCs, specially those that are at the margin of capital adequacy requirement.
- Higher risk weight will also increase the regulatory cost for lenders, thereby impacting lending rates and margins. Since retail lending margins are higher than corporate lending, the narrowing of spreads on retail lending will reinforce the margin pressure for lenders, particularly those having larger uncollateralized lending.
- Retail NBFCs dependent on credit lines from banks will face a double whammy. Their cost of funds will rise due to a 25pp higher risk weightage applied by banks along with curtailment for flows, and higher risk weight on retail lending by NBFCs.
- Currently, the risk weight for lending to ‘AAA-rated NBFCs is 20%, for ‘AA-rated is 30%, and for A-rated NBFCs is 50%. So RBI’s guidelines will impact most of the NBFCs.
- Since RBI’s actions are directed towards specific high-growth components of non-collateralized and NBFC lending of banks, as they slow lending in response to higher risk weights and tighter sub-category limits, the GNPA ratios on retail lending will likely rise faster.
- As per our earlier (Apr’23) sensitivity analysis, 1pp decline in bank lending growth leads to 0.20pp rise in GNPA ratio and 1pp decline in retail inflation raises the GNPA ratio by 0.60pp. Accordingly, in a scenario of inflation declines to 5% (earlier 7%) and credit growth slows to 10% (earlier 15.6%), systemic GNPA ratio was projected to rise by 200bp from an estimated level of 3.5% for FY23E (3.9% actual, RBI).
- As of now, inflation has indeed declined to 4.9% (Oct’23) and credit growth remains mostly unchanged at 15.3%. Hence, as the lagged impact of monetary tightening gets reinforced by credit tightening by RBI, the expected deceleration in high-growth retail lending should translate into higher retail NPA ratios as well.
- Industrial lending of banks has already been lackluster, with a projected annualized growth of 6-7%, due to the lack of private capex and contraction in sales of non-finance companies (-2% YoY in 2QFY24). With restrained retail lending and NBFC-dominated services sector credit, the overall bank lending growth can decelerate closer to 10% in the next three quarters. So, while we have been guiding for bottoming out of the NPA cycle, the rise can be sharper now.
- If indeed, bank and NBFC retail lending were funnelling into financial market speculation, credit tightening by the RBI can trigger sharp volatility in small-cap stocks and small PSBs stocks that have experienced extraordinary rises in valuations.
- Given that the average real HH income has remained flat over the past years (based on our study on PLFS data and the decline in HH savings), the sub-par recovery in HH consumption is being held up by leveraged spending. Our consumption demand function shows that while higher rates would impact real consumption, the larger impact can come from the tightening of retail credit, which may result from both restrained lending and a rise in NPAs. Thus, RBI liquidity tightening through OMOs and higher risk weightage should also slow overall HH consumption.
- Slower credit demand should ease pressure on the Gsec yield curve and reduce spreads for banks.
