PC: Business Standard
While the recent reduction in risk weights for banks’ lending to non bank financial companies (NBFCs) and the microfinance sector has been expected to help these sectors gain more funding, Fitch Ratings said, it is unlikely to happen soon. While the RBI’s regulatory easing measures have helped ease liquidity, banks are anticipated to repress lending practices, which will be dominated by overall liquidity limitations and priority of risk and funding expenses.
A partial reversal of the tightening measure in November 2023 that had increased risk weights on banks lending to NBFCs and unsecured retail credit, was done by the RBI. Under the new guidance, although higher risk weights on unsecured personal loans continue to apply to banks lending to microfinance clients, the banks’ lending to these microfinance clients is exempted from any of these increased charges. Also, the extra 25 percentage points of risk weight on bank loans to NBFCs will be dropped, potentially easing the situation for such financial entities.
Potential Impact on NBFCs and Microfinance
These changes could improve banks’ regulatory capital ratios approximately 30 basis points, according to Fitch. It may result in larger NBFCs with strong credit profiles that renegotiate their terms of funding with the banks on account of the lower risk charges. However, banks are less likely to be willing to become more risk accepting when it comes to lending than smaller and mid sized NBFCs, which mainly rely on bank funding, therefore benefiting from any increase in bank funding less than fully.
Taking the risk weight adjustments to result in additional bank lending to microfinance borrowers and NBFCs that specialize in microfinance, the microfinance sector could benefit. The influx of this much funding should allow liquidity pressures and improve asset quality in the sector. But banks’ lending may in fact remain constrained by their own asset quality issues, especially among mid to small private banks particularly those that engage heavily with microfinance lending.
Broader Implications for the Financial Sector
The Fitch cautious outlook highlights the remaining challenges for NBFCs and in particular the microfinance sector that has been contending with a very complex financial landscape. This argues in favour of a stable liquidity environment for banks as it is likely that banks will remain conservative in their lending practices.
With the changing funding landscape, NBFCs and other microfinance entities may have to resort to alternative approaches to funding to improve their capital positions. It could involve tapping into private equity, securitization options, business operational efficiencies that lead to access to more burdensome lending terms.
The RBI’s regulatory changes lay down a framework for some relief but the wide funding fallout of NBFCs will be immediate. NBFCs have to clearly engage with the continued risk aversion of banks to the lending environment and the additional liquidity challenges, and have a strategic approach for getting funding for their growth and stability.
