The Reserve Bank of India (RBI) move to raise risk weights on consumer loans would potentially increase borrowing costs for non banking finance companies (NBFCs). In a bid to curb high growth in unsecured lending, the RBI increased the risk weight on exposure to consumer credit, including personal loans, to 125% from the previous 100% for both banks and NBFCs. This change is expected to have a significant impact on higher-rated NBFCs, especially those with substantial exposure in the unsecured lending segment.
Borrowing from banks has traditionally been a preferred source of funding for NBFCs, constituting 41.2% of their total borrowings as of March 2023. The RBI’s move is anticipated to push up the cost of borrowing from banks for NBFCs by 10-30 basis points. As a consequence, bonds and commercial papers could become more attractive sources of funding for NBFCs.
Specifically, the risk weight on “AAA” rated NBFCs will surge to 45% from the earlier 20%, and this percentage will increase further for lower-rated entities. However, entities rated “BBB” and below will not face changes in risk weight, thereby providing some shielding for them.
In addition to affecting the cost of borrowing, the increased risk weight could potentially impact the common equity tier-I capital of NBFCs, particularly those with a higher share of unsecured consumer loans. This could have a cascading effect on the capital ratios of NBFCs, with an expected impact ranging from 30 to 450 basis points. SBI Cards and Payment Services and Bajaj Finance are likely to be the most affected.
Constraint on bank lending
The RBI’s move is also seen as a constraint on banks’ lending to NBFCs, potentially prompting NBFCs to issue more bonds to secure funding. The increased supply of bonds is expected to push yields on corporate bonds up by 5-10 basis points, particularly for papers maturing in up to three years.
Given the liquidity crunch in the banking system, the move could result in increased fundraising by NBFCs through commercial papers. Rates on three-month commercial papers issued by NBFCs are expected to rise by 5-10 basis points from the current range of 7.75-7.95%.
This shift in the borrowing landscape could lead to a rise in bond issuances by impacted NBFCs and banks looking to bolster their capital buffers. With interest rate hikes by major central banks making external commercial borrowing and dollar bonds less favourable, raising funds through bonds remains a viable option.
The increased risk weight is anticipated to create an additional supply of bonds in the market, contributing to the cyclical rise in fundraising through bonds observed from October to March. However, this increment in supply may coincide with reduced inflows in dated debt schemes of mutual funds, which are significant investors in bonds with maturities of up to three years.
In summary, the RBI’s recent move is expected to reshape the funding landscape for NBFCs, prompting them to explore alternative sources such as bonds and commercial papers while potentially impacting their borrowing costs and capital adequacy ratios.
