RBI eases risk weight on consumer credit and bank loan: relief for NBFCs and Microfinance Institutions

Introduction

Amidst the economic slowdown, Reserve Bank of India (RBI), in its recent move to bolster and augment credit flow to the retail segment involving microfinance institutions and non-banking financial companies (NBFCs), has undertaken revision of the risk weights of certain bank loans to microfinance institutions and NBFCs, post holding consultations with NBFCs and banks in terms of: (i) the RBI Notification No. RBI/2024-25/119DOR.CRE.REC.63/21.06.001/2024-25 on Review of Risk Weights on Microfinance Loans dated 25 February 2025 (Microfinance Loan Notification); and (ii) RBI Notification No. RBI/2024-25/120 DOR.STR.REC.61/21.06.001/2024-25 on Exposures of Scheduled Commercial Banks (SCBs) to Non-Banking Financial Companies (NBFCs) – Review of Risk Weights dated 25 February 2025 (NBFC Notification), respectively, and shall cumulatively be referred to as the (2025 Notifications). By way of the said revision in risk weightage for bank loans, requiring adjustment in capital requirements for banks, RBI aims at stabilising the financial sector.

Pursuant to the 2025 Notifications: (i) RBI reduced the risk weight for microfinance loans in the nature of consumer credit from 125% to 100%; and (ii) the risk weights for bank loans to NBFCs rated A and above were reduced by 25 percentage points in cases where the extant risk weight as per external rating of NBFCs was below 100%, thereby reversing the increase in risk weightage in terms of the NBFC Notification. This move is a strategic response to the evolving dynamics of the retail segment.

The revised risk weight provisions under the Microfinance Loan Notification are applicable to both outstanding and new loans, effective immediately from the date of issuance of the said notification, while the instructions under the NBFC Notification shall be operational from 1 April 2025.

Key changes pursuant to the 2025 Notifications:

Impact of the 2025 Notifications

The market expectations are that the 2025 Notifications would result in increased credit availability and lending capacity of banks, as reduction in risk weights implies a reduction in the capital that banks must set aside for extending loans. In other words, with lower capital requirements, banks have more flexibility to extend credit. As this will drive the banks towards increased lending to the microfinance sector and NBFCs it is expected to increase credit availability in the retail segment, benefiting both NBFCs and microfinance institutions.

The reduction in risk weights will also improve capital adequacy ratios of banks, allowing them to operate with optimal leverage and reducing the need for short-term capital raises. However, maintaining the risk weight as per the revised standards ensures that banks remain cautious and helps striking a balance between risk, growth objectives and financial stability.

Banks would also be required to make some operational adjustments as a consequence of the 2025 Notifications and they will need to update their internal policies and systems to align with the new risk weight framework, ensuring compliance and optimising their lending strategies.

Comment

The NBFC and microfinance sectors were experiencing a slowdown in terms of lending due to a tightening of the lending norms by the RBI when it increased risk weight by way of the November 2023 Notification. Rolling out the 2025 Notifications is a significant step towards the broader strategy of RBI to enhance credit flow and stabilise the financial sector.

The above move signifies a pivotal step toward bolstering the financial sector by enhancing credit flow and supporting economic growth and the 2025 Notifications also evidence a more balanced regulatory approach on part of the regulator, addressing both risk management and the need for economic growth.

Despite the positive impact, growth in the microfinance and NBFC segments may remain subdued due to asset quality challenges. While this recent move of the RBI presents opportunities for banks and NBFCs, it also acknowledges the need to manage asset quality risks effectively. Nevertheless, by recalibrating risk weights, the central bank aims to stimulate credit flow, provide regulatory clarity, and balance growth with financial prudence.

• Manisha Shroff (Partner); Arijit Sarkar (Counsel) and Shubha Ojha (Associate)

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