On Tuesday, the central bank reversed the increase in risk weight – or the capital that banks must set aside for every loan to cover for potential loss – on loans to NBFCs, in a move that’s expected to make it easier for banks to boost on-lending, which has been constrained by higher capital requirements.
“Lending to NBFCs constitutes 9% of overall banking system credit. Revision in risk weights to the pre-November 2023 levels will free up capital for banks and provide additional headroom for credit growth to them. On the other hand, for NBFCs, banks have been a significant source of funding, which was seeing a secular uptrend till the November 2023,” said Ajit Velonie, senior director, Crisil Ratings.
The central bank had in November 2023 hiked risk weights on banks’ exposure to NBFCs by 25 percentage points, over and above the risk weight associated with the given external rating. RBI had then also hiked the weights on certain consumer credit segments such as personal loans and credit cards. On 26 February, it rolled back the hike in risk weights on bank loans to NBFCs and also certain microfinance (MFI) loans. The revised risk weights will be effective 1 April 2025.
After the implementation of the RBI’s November 2023 circular, bank lending to NBFCs stood almost flat at ₹13 trillion for three quarters till September 2024, seeing some revival only in the recent December 2024 quarter. Restoring risk weights to the pre-November 2023 levels could lead to additional credit flow from banks to NBFCs, Velonie explained.
Bank credit to NBFCs slowed to 6.7% in 2024, from 15.0% in 2023, as per latest RBI data. The year-to-date figure (as of December 2024) for FY25 was at 4.8%, also much lower than the 13.2% growth in the year-ago period.
Regulatory shift
“We think the RBI now is more comfortable (with the normalisation in bank credit to NBFCs). MFI sector is also seeing a lot of stress and hence any relaxation here could improve credit flow,” Macquarie Research said in a note.
Since Sanjay Malhotra took over as governor in December, the RBI has infused liquidity into the banking system, including through open market purchases of bonds, cut the policy repo rate for the first time in five years, deferred implementation of various regulations like ECL (expected credit loss), project finance and LCR (liquidity coverage ratio) and now relaxed risk weights, the global research firm said, adding that this bodes well for the financial sector and lays more emphasis on consumption and growth.
“We believe this is good for the financial sector to re-rate and reiterate our bullish view,” it said.
Mahesh Thakkar, director general of FIDC, said that the RBI’s move to reduce the risk weights will bring in a lot of money and confidence around the sector.
“Banks will be further encouraged to lend to NBFCs, particularly in priority sector. The new RBI governor has come in and the Union budget was also positive on consumption and then the repo rate cut happened, so all these things are moving in the right direction with a focus on growth and liquidity, giving positive indications,” he told Mint.
Need more funding avenues
Meanwhile, to compensate for the slower credit flow from banks, NBFCs have increased reliance on short-term funding tools such as commercial papers (CPs)–where outstanding volumes have touched their highest level since 31 October 2019.
Total volume of outstanding CPs stood at ₹4.8 trillion as of 7 February, 2025, as per RBI data.
As per a recent report by India Ratings, CPs maturing in February, March and April 2025 amounted to ₹1.2 trillion, ₹1.6 trillion and ₹34,000 crore, respectively, as of 17 February. Of these, the highest issuances were by NBFCs at 47%, followed by corporates at 35%, public finance entities at 15%, and public entities at 3%.
“With expectations on another cut in policy rates in upcoming meeting of MPC and further decline in long-term borrowing costs, large borrowers have increased the share of their borrowings through commercial papers (CPs), as it may be advantageous to borrow through long-term funding on a later date, when these long-term rates decline,” said Anil Gupta senior vice-president, financial sector ratings, ICRA.
Faced with a liquidity crisis, banks too have been relying more on capital markets, with total volume of outstanding certificates of deposits (CDs)–short term papers issued by banks to raise funds—at a record high of ₹5.2 trillion as of 7 February.
Macquarie Research believes that relaxation in risk weights will ease credit flow, and could also result in some reductions in interest rates on a selective basis for well-rated NBFCs.
“Banks almost fund 50% of fund requirements for NBFCs (including subscribing to debt papers),” it said, adding that on their part, banks should see a positive impact of 20-250 bps on their common equity tier-I (CET-1) capital, with IndusInd Bank and Bandhan Bank being the biggest beneficiaries.
However, others believe that this is the first of many steps and more needs to be done to develop alternate funding mechanisms if over reliance on banks is a concern.
“There are hardly any avenues to raise funds,” FIDC’s Thakkar said, adding that the body has suggested the need for a funding mechanism in the form of a refinancing window like the one for housing finance companies via National Housing Bank (NHB). “For NBFCs, SIDBI or any other financial institution can take up this role. This would greatly help the sector, particularly medium and base layer NBFCs,” he said.
