Your personal loan's interest rate is likely to increase soon because of Reserve Bank of India's (RBI) latest directive. Amid concerns of abnormally high growth in unsecured loan categories, RBI on Thursday announced stricter norms for banks and non-banking financial companies (NBFCs) in relation to unsecured lending portfolios.
RBI has increased the risk weights in respect of consumer credit exposure of commercial banks and NBFCs (outstanding as well as new), by 25 percentage points to 125%. The decision excludes housing, education, vehicle loans and loans secured by gold or gold jewellery from the higher risk weight. Similarly, credit card receivables of scheduled commercial banks (SCBs) attract a risk weight of 125% while that of NBFCs attract a risk weight of 100%. On a review by RBI, the risk weights on such exposures has been increased by 25 percentage points to 150% and 125% for SCBs and NBFCs. Moreover, risk weight on bank credit to NBFCs has been increased by 25 percentage points
Risk weightage is a measure used in the banking industry to assess the risk associated with different types of assets, including loans. The risk weight assigned to a particular asset influences the amount of capital a bank is required to hold as a buffer against potential losses. In the context of credit cards and personal loans, an increase in risk weightage can lead to an increase in interest rates. Banks are required to maintain a certain level of capital adequacy to ensure they have enough capital to cover potential losses. The risk weight assigned to different types of loans is a key factor in determining the amount of capital a bank must hold. The increase in risk weights will affect the capital adequacy ratio of lenders, thereby making them set aside more capital for such loans. This will make loans more expensive, directly impacting the borrowers.
"Majority of the online lending apps procure capital from other NBFCs or Banks. NBFCs whose capital mix is skewed towards bank borrowings will suffer a dual impact. One – they have to set aside additional capital for lending in the unsecured category and second the banks who are lending to them also have to set aside additional capital, thus leading to higher cost of capital. Since majority of online lending apps cater to consumer loans, the overall demand for such loans might go down as they are non-essential in nature. For the existing loans, the ROI will increase and will affect the creditworthiness of the borrowers who are at the higher end of debt-to-income ratio, " said Gurjot Singh, Co-founder, Collekto, a fintech company specialising in retail debt collections.
Delinquency numbers for unsecured loans below Rs 50,000 was already at 5.4%. This would go higher as the number of borrowers who default increase and at the same time fresh lending rate goes down, added Singh.
"If the risk weight for credit card and personal loan portfolios increases, banks may need to allocate more capital to cover these loans, and one way to compensate for this is by increasing interest rates. Also as risk weightage increases, banks may become more cautious in extending credit to consumers, especially those with a higher perceived risk. This could result in some individuals finding it more challenging to obtain credit cards or personal loans. Those who are still eligible for credit might face stricter terms and conditions. If a bank raises interest rates on existing credit card balances or personal loans due to increased risk weightage, it directly affects consumers who already have outstanding debt. This can lead to higher monthly payments and increased overall borrowing costs for existing borrowers," said Mahesh Shukla, CEO & Founder, PayMe.
Last month, Business Today reported about a notable surge in unsecured lending, shedding light on the growing defaults on debt resolution platforms. RBI Governor Shaktikanta Das' statement on October 6, 2023, also highlighted the high growth in consumer credit and advised banks and NBFCs to strengthen their internal surveillance mechanisms, address risk build-up, and implement safeguards. In July and August 2023, Das also highlighted the increasing dependency of NBFCs on bank borrowings.
Credit card outstanding increased 30% year on year (y-o-y) in September 2023, other personal loans increased 25%, and consumer durable loans increased 11%, according to RBI data. During the same time period, overall bank credit increased by 20%. The significant rise in delinquencies in unsecured retail segment has led the regulator to take measures to create a stable environment for Indian economy as compared to its counterparts. Although the overarching message is to increase banks' sensitivity and encourage them to be proactive and prudent, this will ultimately result in a reduction in unsecured lending. Besides, the increase in interest rates might lead to borrowers’ reducing their risk appetite and opt for a small ticket size loan, explains Singh.
"Borrowers on online lending apps which rely on Banks and NBFCs to finance the borrowers will see a jump in their lending rates due to this rule. However, lending apps that work with P2P lending companies will not be impacted as this rule doesn’t apply to them," said Bhuvan Rustagi, COO and Co-Founder, Per Annum & Lendbox.
"Online lending apps often operate in a dynamic and competitive environment, and their response to an increase in risk weightage on credit cards and personal loans can vary based on their business models, risk management strategies, and market positioning. One of the most direct impacts is the potential for online lending apps to increase interest rates on credit cards and personal loans. This is to compensate for the perceived increase in risk and to maintain profitability. Borrowers may see an increase in the cost of borrowing compared to previous rates. It's important for borrowers using online lending apps to stay informed about any changes in interest rates, terms, and conditions. Additionally, they should regularly review their own financial situation and creditworthiness to make informed borrowing decisions," added Shukla.
The RBI has also declared that all regulated entities are required to implement the new rules by February 29, 2024. The move can be seen as the RBI's response to a rising trend in unsecured loans that could be a systemic risk for financial institutions.
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