The Reserve Bank of India’s (RBI) recent decision to raise the risk weight on consumer credit is poised to reshape lending dynamics, with co-lending partnerships between banks and non-banking financial companies (NBFCs) expected to witness a notable uptick. This move, aimed at addressing the evolving financial landscape, is likely to be particularly embraced by smaller NBFCs facing potential cost escalations in capital markets.
Impact on smaller NBFCs
The appeal of co-lending is anticipated to be more pronounced among smaller NBFCs, leveraging their geographical and industry specific specializations. Focused on localized markets, these entities are projected to adopt co-lending more assertively, utilizing their specialized knowledge. Larger players may also engage in co-lending, but with a potentially less aggressive approach.
The co-lending model in the Indian banking sector, pioneered in 2018 to enhance credit flow to underserved sectors, continues to face notable challenges. While it has gained momentum with numerous partnerships between banks and NBFCs, a range of issues have surfaced, requiring careful consideration.
Since its introduction, the co-lending model has become a key feature of India’s financial landscape, designed to foster greater access to credit in sectors traditionally facing difficulties securing funding. The concept is structured as an 80:20 partnership between banks and NBFCs, with the primary goal of distributing risk while focusing on long-term structural reforms.
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.
Bank borrowings
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%.
