RBI eases risk weight norms for bank exposures to NBFCs, reverses earlier hike

In a significant move to ease liquidity pressures on Non-Banking Financial Companies (NBFCs), the Reserve Bank of India (RBI) has decided to restore the risk weights on exposures of Scheduled Commercial Banks (SCBs) to NBFCs to their original levels, reversing a 25-percentage-point hike introduced in November 2023. The revised norms will come into effect from April 1, 2025, as per a notification issued by the central bank.

Background: The November 2023 Hike

In November 2023, the RBI had increased the risk weights on bank exposures to NBFCs by 25 percentage points for all cases where the existing risk weight, based on the external rating of the NBFC, was below 100%. This move was part of the RBI’s broader regulatory measures to address growing concerns over unsecured consumer credit and the rapid expansion of bank lending to NBFCs. The hike was intended to strengthen the resilience of the banking sector by requiring banks to set aside more capital for such exposures.

The Latest Decision: Restoring Original Risk Weights

In its latest review, the RBI has decided to roll back the additional 25-percentage-point hike. Effective April 1, 2025, the risk weights on SCBs’ exposures to NBFCs will be determined solely by the external rating of the NBFC, as per the Master Circular – Basel III Capital Regulations dated April 1, 2024. This means that the risk weights will revert to the levels specified in Paragraph 5.8.1 of the circular, which aligns with international Basel III norms.

Rationale Behind the Reversal

The RBI’s decision to restore the original risk weights is seen as a move to:

1. Ease Liquidity for NBFCs: The November 2023 hike had increased the cost of borrowing for NBFCs, as banks were required to allocate more capital for lending to them. This had tightened liquidity for NBFCs, which play a critical role in providing credit to underserved sectors of the economy.
2. Support Credit Growth: By reducing the capital burden on banks, the RBI aims to encourage higher lending to NBFCs, which in turn can boost credit flow to sectors like micro, small, and medium enterprises (MSMEs), housing, and retail.
3. Align with Basel III Norms: The restoration of risk weights based on external ratings ensures that the regulatory framework remains consistent with global Basel III standards.

Impact on Banks and NBFCs

• For Banks: The reduction in risk weights will free up capital for banks, enabling them to increase lending to NBFCs without additional capital constraints.
• For NBFCs: The move is expected to lower borrowing costs and improve access to funds, particularly for highly rated NBFCs. This could lead to increased lending activity and support economic growth.
• For the Economy: The decision is likely to have a positive ripple effect, as NBFCs are key intermediaries in channeling credit to sectors that are often underserved by traditional banks.

Effective Date and Other Instructions

The revised risk weights will come into effect from April 1, 2025. The RBI has clarified that all other instructions outlined in the November 2023 circular remain unchanged. This includes measures related to unsecured consumer credit and other regulatory provisions aimed at ensuring financial stability.

Industry Reactions

Industry experts have welcomed the RBI’s decision, calling it a “timely and pragmatic move” that balances the need for financial stability with the imperative to support credit growth. NBFCs, in particular, have expressed relief, as the earlier hike had significantly increased their cost of funds.

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