Market jitters: Banking stocks dip after RBI decides on unsecured consumer loans

The Reserve Bank of India's (RBI) decision to increase credit risk weights on unsecured consumer loans has sent shockwaves through the financial markets, prompting a decline in banking stocks. This move, aimed at curbing the rapid growth of personal loans and credit cards, has heightened concerns about the proliferation of such borrowings.

Indian equity benchmarks, which had enjoyed a two-day winning streak, faced a downturn on November 17. The Sensex closed lower by 187.75 points, or 0.28 per cent, at 65,794.73, while the Nifty dipped by 33.40 points, or 0.17 per cent, closing at 19,731.80. Despite the market setback, BSE Sensex and Nifty50 recorded a weekly gain of 1.5 per cent each.

On Thursday, the RBI implemented a 25-percentage-point increase in risk weights on unsecured personal loans, credit cards, and lending to Non-Banking Financial Companies (NBFCs), bringing it to 125 per cent with immediate effect. This move implies that entities will now need to lend at higher interest rates and raise additional capital. S&P Global estimates a decline of about 60 basis points in the banks' core, or tier-1, capital adequacy.

The financial services firm said that finance companies will bear a more substantial impact as their incremental bank borrowing costs surge, coupled with the effects on capital adequacy. The RBI's considered decision follows Governor Shaktikanta Das's warning a little over a month ago about high stress in unsecured lending portfolios and the potential for increased delinquencies in this segment. Besides banks and NBFCs, financial technology firms face heightened exposure to these loans, with around 80 per cent of their personal loans being unsecured, according to S&P Global.

The Nifty Bank witnessed a 1.3 per cent decline, with IDFC First Bank, SBI, Axis Bank, Bandhan Bank, and PNB experiencing drops of 2-3 per cent each. The RBI's intervention to address the surge in consumer loans reflects its ongoing warnings to banks and Non-Banking Financial Companies (NBFCs) regarding the risks associated with uncontrolled growth in this sector.

The central bank's revision of credit risk weights necessitates higher capital requirements for banks and NBFCs dealing with unsecured consumer loans, impacting their lending practices. This move aligns with the RBI's efforts to manage the risks associated with the relentless rise in consumer loans. The immediate effect of the change has sparked concerns about potential higher interest rates for borrowers, a drawdown in capital adequacy, and a potential impact on profits.

S&P Global Ratings suggests that while the recent changes may not immediately impact the risk-adjusted capital ratios of banks and NBFCs, borrowers can expect higher interest rates. The increase in risk weights, particularly on unsecured personal loans and credit cards, is estimated to reduce banks' core capital adequacy by about 60 basis points. Financial services firm S&P Global emphasises that finance companies will be particularly affected, facing rising bank borrowing costs and capital adequacy impact.

Analysts anticipate a slowdown in loan growth, especially for NBFCs, as the revised risk weights dampen lending prospects. Geeta Chugh, credit analyst at S&P Global, notes that this shift may lead to slower loan growth but will likely support asset quality in the Indian banking system.

As of March 31, banks' borrowings, a significant funding source for NBFCs, make up 41.2 per cent of their total borrowings. The rise in credit risk weight is expected to elevate borrowing costs, subsequently leading to increased expenses for lending, impacting both banks and NBFCs.