Moody’s Analysis: Positive Impact of Higher Risk Weight on Unsecured Bank Loans

Moody’s Investors Service has provided a positive assessment of the Reserve Bank of India’s (RBI) decision to tighten norms for unsecured personal loans. This move, according to Moody’s, is credit positive because it necessitates higher capital allocation for such loans, thereby enhancing lenders’ loss-absorbing capabilities.

RBI’s Decision and Its Implications

The RBI recently increased risk weights on unsecured retail loans, credit cards, and lending to non-banking finance companies (NBFCs) by 25 percentage points. Moody’s views this as a prudent step considering the rapid growth of unsecured loans in recent years, which could potentially expose financial institutions to elevated credit costs during economic or interest rate shocks.

Strengthening Loss-Absorbing Buffers

Moody’s statement highlights that the tightening of underwriting norms through higher risk-weighted assets is beneficial for lenders. This requirement compels them to allocate more capital for unsecured loans, thereby strengthening their loss-absorbing buffers. Additionally, it may moderate their appetite for aggressive loan growth, promoting a more sustainable lending environment.

Competitive Dynamics in Unsecured Lending

The analysis points out that India’s unsecured lending segment has become highly competitive, with banks, NBFCs, and fintech companies actively expanding loans in this category. Over the past two years, personal loans grew by approximately 24%, and credit card loans saw a 28% increase, outpacing the overall banking sector’s credit growth of around 15%.

Sector-Wide Capitalization

Moody’s also notes that the banking sector’s exposure to unsecured retail credit stands at around 10% of total loans as of September 2023. Moreover, the sector’s overall capitalization remains robust, with a Common Equity Tier 1 ratio of 13.9% as of March 2023. This indicates that banks should be able to absorb the higher risk weights on their capital effectively.

Individual Impact on Lenders

While the new underwriting rules will have a positive systemic impact, Moody’s acknowledges that individual lenders may experience varying effects based on their exposure to unsecured loans. Nonetheless, the overarching effect is expected to be a strengthening of the banking sector’s resilience against credit risk, aligning with regulatory goals of prudent risk management.