The Reserve Bank of India (RBI) has reduced the risk weights on bank loans to NBFCs and Microfinance Institutions (MFIs) to boost credit flow and enhance lending to the retail sector.
What is the Risk Weight on Loans and Its Impact on NBFCs and Banks?
About:
- Risk weight is a percentage factor assigned to a bank’s assets, including loans, to determine the amount of capital required to cover potential losses.
- A higher risk weight increases capital requirements, making loans costlier, while a lower risk weight reduces capital needs, enabling more lending.
Criteria for Risk Weights:
- Risk weights depend on credit ratings, asset type, and regulatory requirements.
- Highly rated borrowers receive lower risk weights, while low-rated borrowers face higher risk weights.
Impact of Lower Risk Weights:
- Encouraging Bank Lending to NBFCs:
- Lower risk weight reduces the capital banks need to hold for loans, increasing their lending capacity to NBFCs.
- Boosting Credit Growth:
- Enhanced liquidity will increase NBFC lending in sectors like housing, consumer finance, and MSMEs.
- The retail sector will benefit from improved access to credit.
- Enhancing Financial Stability:
- Increased credit availability will promote employment, income levels, and financial resilience in the economy.
Capital Adequacy Ratio (CAR)
About:
- CAR is a measure of a bank’s financial strength, ensuring it has enough capital to absorb potential losses and protect depositors.
Components of CAR:
- Tier-1 Capital:
- Core capital (equity, share capital, retained earnings) used to absorb losses while the bank continues operations.
- Tier-2 Capital:
- Secondary capital (unaudited reserves, subordinated debt) used when the bank is winding down.
Regulatory Requirement:
- Basel III norms mandate a minimum CAR of 8% globally.
- RBI mandates Indian banks to maintain a CAR of 9%.
Importance:
- A higher CAR indicates better financial stability, making banks more resilient to financial crises.
What are Non-Banking Financial Companies (NBFCs)?
About NBFCs:
- NBFCs provide loans, financial securities, leasing, and insurance services but do not hold a banking license.
- Unlike banks, NBFCs cannot issue cheques or be part of the payment system.
- Registered under the Companies Act, 1956 and regulated by RBI.
- NBFCs require an investment-grade credit rating.
Key Services Offered:
- Personal loans, home loans, vehicle financing, gold loans, microfinance, infrastructure financing, investment management, insurance services.
Classification of NBFCs
By Major Activity:
- Asset Finance Company
- Investment Company
- Loan Company
- Infrastructure Finance Company
- Core Investment Company
- Infrastructure Debt Fund
- Microfinance Institution (NBFC-MFI) (Malegam Committee Recommendation)
- NBFC-Factors
- Mortgage Guarantee Companies
- Non-Operative Financial Holding Company
By Deposits:
- Deposit-Taking NBFCs
- Non-Deposit Taking NBFCs:
- Systemically Important (NBFC-NDSI) (Assets of ₹500 crores or more)
- Other Non-Deposit Holding (NBFC-ND)
| Regulation of NBFCs | |
| Type of Institution | Regulatory Authority |
| NBFCs registered with RBI | RBI |
| Housing Finance Institutions | National Housing Bank |
| Merchant Banking, Venture Capital, Stock Broking, Collective Investment Schemes (CIS) | SEBI |
| Nidhi Companies, Mutual Benefit Companies | Ministry of Corporate Affairs (MCA) |
| Chit Fund Companies | State Government |
| Insurance Companies | IRDAI |
| Non-Banking Non-Financial Companies | Companies Act 1956, MCA, State Governments |
Benefits of NBFCs:
- Financial Inclusion: Extends credit to underserved sectors.
- Innovative Products: Provides tailored financial solutions.
- Liquidity: Enhances money flow in the economy.
- Support for MSMEs: Crucial for small businesses and startups.
Challenges of NBFCs:
- Funding Constraints: Dependence on market borrowings.
- Asset Quality & Credit Risk: Higher NPAs than banks.
- Regulatory Compliance: More stringent RBI norms.
- Corporate Governance Issues: Cases like IL&FS crisis highlight risks.
NBFCs play a crucial role in India’s financial system by catering to sectors underserved by banks. RBI’s recent move to reduce risk weights will increase liquidity, improve credit flow, and boost economic growth. However, challenges like funding constraints, regulatory risks, and financial stability must be managed effectively.
