Risk weights

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Section: Markets
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Short head: Risk weights may squeeze banks’ prospects.

Short strap: RBI has tightened norms for unsecured
lending, posing medium-term challenges for banks.
Notification: Risk weights an overhang, tame medium-

term outlook on banks
HL: SBI, Bajaj Fin, Axis Bank face the heat of unsecured
lending norms. What should investors do next?
Strapline: After the availability of credit through mobile

phone apps and minimal documentation soared, personal loans
and credit cards recorded a sharp growth. The risks rose as
borrowers opted for multiple loans, forcing the RBI to step in
with tightened norms. Growth in the segment may slow down in
the medium term. So, what is in store for investors.
By Alekh Angre
The Reserve Bank of India’s move to make margin-
accretive unsecured lending costlier has thrown a spanner
in the growth prospects of banks and finance companies.
Retail loans, which comprise home loans, personal loans,
car loans, along with bank loans to non-banking financial
companies (NBFCs) is estimated to account for around
half of the incremental credit over the last one year.
To put this rapid growth in context, take the case of Bajaj
Finance. The leading consumer durable and personal loan
financier added 7.4 million new customers between April
and September 2023. This is more than the 6.1 million
customers it added in a financial year six years ago.
Between FY18 and FY23, new customer additions have
nearly doubled.
To some extent, these numbers can be considered as the
tip of the iceberg. While Bajaj Finance has stringent and
time-tested loan underwriting filters, there are many
fintech companies and last-mile lenders who are popular
among the ‘no income and no job’ (NINJA) borrowers,
analysts said.
It simply means that more people are buying cars and
taking personal loans, especially small-ticket loans.
According to bankers and credit bureau officials, small-
time borrowers served by fintechs and NBFCs are highly
leveraged, and this has led to increase in risk of defaults.
Gaurav D, a 27-year old from Mumbai and working in a
small company as part of the admin team, keeps
borrowing from lending apps to clear earlier loans.
Initially, unemployment during pandemic forced him to
borrow from loan apps to clear existing debt. But,
considering the ease with which he can take loans from
these apps, Gaurav now also funds his lifestyle on credit.
Analysts said that such cases have made the regulator
nervous, given the systemic implications in case of
defaults.
On November 16, the central bank hiked risk weights on
consumer loans–excluding home, education, vehicle, and
gold loans– and credit card exposures by 25 percentage
points.
The impact
The focus is on consumption and personal loans. The
stricter rules are expected to hit the capital levels of
lenders and also force them to go slow with unsecured
lending to conserve capital. Simply put, banks will have
to keep aside more capital against such loans.
Analysts and fund managers point out that most of the
large lenders have comfortable capital buffers. So, even
after taking the hit on capital on account of higher risk
weights, the levels remain above the regulatory
requirement. The same is the case for most impacted
NBFCs, such as Bajaj Finance and SBI Cards.
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Large banks and NBFCs are best placed to adapt to
changes and also have the balance sheet capacity to
absorb any cost.
A senior official with a Mumbai-based private bank.
In addition, they will look to pass on this cost to the
borrowers.
“Higher growth in unsecured lending is also a reflection
of higher demand. Banks were ready to jump in because
they were confident with their underwriting models. Also,
as these loans are high-yielding, they offset the impact on
Net interest margin (NIM) on account of deposit
repricing. This changes with the RBI’s latest directions as
lenders become selective in lending and change their
business model. Large banks and NBFCs are best placed
to adapt to changes and also have the balance sheet
capacity to absorb any cost. Ultimately, demand is very
much strong and lenders will grab this opportunity,” said
a senior official with a Mumbai-based private bank.
Shares of banks and NBFCs tumbled when the market
opened on November 17, a day after when the RBI
announced tightening of capital norms for unsecured
retail loans. The Nifty PSU Bank index fell 2.4% with the
country’s largest lender, State Bank of India, closing the
day 3.7% lower. The index for private banks was down
1.3%. While RBL Bank fell the most (8%), larger banks
like Axis Bank and ICICI Bank of India slipped 3.1% and
1.5%, respectively.
Both indices ended flat on Monday (November 20).
Hit on Tier-1 capital
S&P Global Ratings estimates that Tier-1 capital
adequacy of banks will decline by about 60 basis points.
Finance companies will be worse affected as their
incremental bank borrowing costs will surge, in addition
to the capital adequacy impact, S&P added.
GFX: Banks, NBFCs to see impact on Tier-I capital

SBI Cards closed 5% on Friday, while Bajaj Finance was
down 2%.
Bajaj Finance may see 220-240 basis points (bps) impact
on the capital level, according to estimates by brokerages.
SBI Cards said the central bank’s move to tighten the
norms will reduce capital adequacy by around 4%, but
there is no need for the company to raise fresh equity
capital.
While the RBI’s move is negative for the entire sector
because it is expected to impact growth multiples, large
lenders are best placed to adapt, and this necessarily does
not change long-term growth prospects.
Big banks in general have had a lacklustre performance in
the stock market.
Among the top five banks by market capitalisation, only
Axis Bank has managed to beat Nifty 50 in the last one
year. HDFC Bank, ICICI Bank, State Bank of India, and
Kotak Mahindra Bank are down. This was due to a
combination of factors such as expensive valuations,
compression in net interest margin due to a rise in deposit
rates, and as investors flocked to mid- and small-sized
banks, especially PSU banks, available at a cheaper
valuation.
GFX: Lenders affected by RBI's rules on unsecured
lending
Bank-specific overhangs in the case of HDFC Bank
(merger with HDFC) and Kotak Mahindra Bank
(succession saga) also added to their downside.
Understanding RBI’s move
Retail loans and lending to NBFCs contributed ~50% of
incremental credit in the last 12 months, according to
Macquarie Capital Securities (India). While retail loan
growth has been strong at 18%-20% for the past several
months, unsecured retail loan growth has been stronger at
25%+ and bank lending to NBFCs has been growing at
30%.
The high growth had caught the regulator’s attention with
the Reserve Bank of India advising to exercise caution.“It
is only to caution the banks to strengthen their internal
surveillance systems, watch the trends and take whatever
measures are required,” RBI governor Shaktikanta Das
said on October 6.
In this context, the RBI’s measures, aimed at reining in
fast growth seen in unsecured loans in a bid to ensure
financial stability, are not surprising, analysts said.
Though, a hike in the risk weights on bank loans to
NBFCs (excluding home finance companies and lending
to non-bank lenders for the purpose of meeting priority
sector norms) has surprised the market. Another element
of surprise is the reclassification of top-up loans, say on
vehicle loan, as unsecured credit.
Data from credit information bureaus showed the risk of
default was mainly in the small-ticket loans of below
INR50,000 with high leverage among these set of
borrowers. Such loans are mainly given by NBFCs and
fintechs and the presence of banks is minimal.
Anticipating stricter regulatory framework, banks had
already dialled back on growth in unsecured lending.
Bankers say that while their portfolios are relatively safer,
increasing risks from those at the periphery, especially
fintech companies, need closer attention. Now with
changes in risk weights, banks will look to pass on the
cost to borrowers including to NBFC borrowers and even
slow down on lending.
Ambit Capital said that whilst a near-term negative, these
proactive measures from the RBI protect banks from any
future impact on asset quality and capital similar to what
they faced in the corporate asset quality cycle.
Separating wheat from chaff
Large private sector banks have a higher share of
unsecured loans, and hence they are expected to see a
bigger impact on their capital. But they are expected to
remain well capitalised even after assuming a hit on the
capital.
However, the stricter norms may force some banks–
especially PSU banks like SBI and PNB–to advance the
capital raising cycle by a year or so, according to
Jefferies.
“We maintain our view to have a greater bias to own
large banks over the mid- and small-sized banks (public
and private), as the historical valuation premium of large
over small banks has narrowed sharply. Large private
banks have better levers to address this possible
slowdown. We do not see any impact on public banks,
including SBI, which have a lower Capital Adequacy
Ratio (CAR) on a relative basis,” Kotak Institutional
Equities said in a report.
According to analysts and fund managers, given the
uncertainty and correction in the share prices of large
banks, long-term investors could enter and pick up these
banks at dips.
In the last one year, the Nifty PSU Bank index rose 30%
compared to 6% gains in the Nifty Private Bank Index.
The RBI’s directions may alter the preference for most
PSU banks as investors would exercise caution
anticipating potential fundraise requirements, which may
lead to share dilution and eventually impact returns.
Another worry is the asset quality.
“Our channel checks and RBI’s Financial Stability Report
(FSR) imply state-owned banks other than the SBI have
high non-performing loans (NPLs) on unsecured loans.
While their unsecured exposures are small, if high NPLs
continue they could remove 15bps-20bps of recently
improved return on assets (RoA),” Nuvama Wealth said
in a report.
Double-trouble for NBFCs
Non-banking finance companies are seen as most
impacted by the RBI’s move. In addition to the hit on
capital, they also have to shell out more on bank
borrowings.
IIFL Securities expects the cost of funds to increase for
the NBFCs, and thereby increasing reliance on market
borrowings. With the banks looking to protect return on
risk-weighted assets on their NBFC exposure, the
brokerage expects banks to increase lending rates by 50
bps-60 bps over the next few quarters, resulting in NIM
pressure for NBFCs.
Jefferies said that NBFCs with a higher share of
unsecured consumer loans like SBI Cards, Bajaj Finance
and Aditya Birla Finance would be most affected by
tighter capital norms. While auto NBFCs may see lower
impact, home finance companies should be least affected.
Meanwhile, home finance companies may see higher
interest from investors as home loans have been excluded
from the stricter capital rules, fund managers said.
Last word
The full impact of the RBI’s move is expected to play out
over the next few months. While the rules are negative for
banks and NBFCs, they prepare the system for any
potential asset-quality issue. Barring the stress in the
microfinance loans, India has not seen a cycle of retail
loan defaults since the global financial crisis of 2008. But
the last round of the corporate bad loan cycle had shown
that the impact on capital and profitability because of
defaults is painful and long.
As lenders balance the trade-off between growth and
profitability, investors are better off tempering their
expectations in the medium term.

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Short head: Risk weights may squeeze banks’ prospects.

Notification: Risk weights an overhang, tame medium-

Strapline: After the availability of credit through mobile

GFX: Banks, NBFCs to see impact on Tier-I capital

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