RBI New Guidelines for Personal Loans

Over the past year, personal loans and credit cards have shown faster growth compared to the overall bank credit growth of approximately 15%. The banks and NBFCs that offer unsecured personal loans, consumer durable loans, and credit cards will need to elevate the risk weights for these loans from the current 100 per cent to 125 per cent.

The global financial landscape is undergoing swift transformations, and unforeseen challenges may arise. The central bank is vigilantly observing the unfolding scenario and taking proactive measures to uphold financial stability.

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The Indian banking sector remains robust, supported by improved asset quality, consistent credit expansion, and strong earnings growth. Credit growth is diverse and grounded in the solid foundations of financial institutions. Non-Banking Financial Companies (NBFCs) exhibit financial indicators aligned with those of the banking system, according to the RBI circular dated October 06, 2023.

The RBI has raised concerns about the rapid growth in specific segments of personal loans, advising both banks and NBFCs to improve their internal monitoring mechanisms. They are urged to address any accumulating risks and implement appropriate safeguards for their benefit.

The Reserve Bank believes that the current imperative is the implementation of robust risk management practices and more stringent underwriting rules. In discussions between the Governor and the MD/CEOs of major banks and large NBFCs in July and August 2023, particular attention was given to the high growth in consumer credit and the increasing reliance of NBFCs on bank borrowings.

To address these concerns, the RBI has decided to take certain measures.

1. Consumer Credit Exposure

i. Commercial Banks: The risk weight for consumer credit exposure of commercial banks, including personal loans (excluding housing loans, education loans, car loans, and gold loans), will be increased by 25 percentage points to 125%.

ii. NBFCs: The risk weight for consumer credit exposure of NBFCs, categorised as retail loans (excluding specified categories like housing loans, education loans, car loans, gold loans, and microfinance/Self Help Group loans), will be increased to 125%.

iii. Credit Card Receivables: The risk weights for credit card receivables will be increased by 25 percentage points to 150% for Scheduled Commercial Banks (SCBs) and 125% for NBFCs.

2. Bank Credit to NBFCs

Twenty-five percentage points will increase risk weights on exposures of SCBs to NBFCs in cases where the external rating risk weight of NBFCs is below 100%. Exclusions include loans to housing finance companies (HFCs) and NBFCs eligible for priority sector classification.

3. Strengthening Credit Standards

i. Financial institutions should review sectoral exposure limits for consumer credit, establishing Board-approved limits for various sub-segments. Furthermore, RBI also advocates prudent risk management, including prescribing limits for unsecured consumer credit exposures and strictly adhering to and monitoring these limits.

ii. Top-up loans against depreciating movable assets, such as cars, will be treated as unsecured loans for credit appraisal, prudential limits, and exposure purposes.

iii. These instructions have been issued under the powers conferred by various banking and financial acts.

How will the new guidelines impact the borrowers and the industry?

The revised regulations will have an effect on unsecured personal loans, credit cards, and loans extended by Banks and NBFCs to other NBFCs for unsecured lending. However, these changes will not apply to secured products such as home loans, education loans, and car loans.

The RBI's decision to increase risk weights for personal loans is a welcome move, coming at the right time after the central bank's warning about excessive lending in the unsecured consumer loans sector.

While the overall financial impact of non-performing loans in this category may not be substantial, the large number of individuals drawn to easy credit for non-productive purposes, such as purchasing consumer durable products and gadgets, is a cause for concern. This step is expected to restrain lenders who may have adopted lax practices in loan assessment, a trend that has historically resulted in unfavourable consequences.

The heightened risk weights for unsecured loans are anticipated to result in increased costs for lending from Banks and NBFCs to lending apps. Hence, this is likely to exert pricing pressure on lending apps.

With the elevated risk weightage from 100 per cent to 125 per cent, lending institutions, including fintech platforms, may consider these loans as riskier assets, leading to increased capital requirements.

In practical terms, this could result in higher interest rates and/or more stringent eligibility criteria for personal loan applicants. As lending institutions adjust to the new regulations, personal loan borrowers may experience an increase in the cost of borrowing or find that getting a personal loan becomes more challenging due to tightened lending rules.

The decision made by RBI's is poised to trigger a sequence of events, leading to slowing down the retail loan consumption and consequently affecting profitability. While this may increase funding costs for NBFCs in the short term, from a broader perspective, it is expected to contribute positively to the overall well-being of the industry.

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Overall, how financial institutions adapt to the regulatory changes and manage the associated risks will influence the impact on personal loan borrowers.

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KETKI JADHAV is a Content Writer at PersonalFN since August 2021. She is an MBA (Finance) and has over seven years of experience in Retail Banking. Ketki specialises in covering articles around banking, insurance, personal finance, and mutual funds and has been doing it for over three years now.

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