Banking, NBFC stocks jump up to 8% as RBI eases risk weight for lending; check details

Shares of small-sized banks and non-banking financial companies (NBFCs) rallied on Thursday, February 27, after the Reserve Bank of India (RBI) eased risk weight norms to boost lending growth.

The central bank on Tuesday lowered the risk weights of loans given by banks to NBFCs to 100% from 125%. Lower risk weights mean banks will have to set aside less capital for loans given to NBFCs, resulting in a substantial release of capital for lending purposes. This would help in improving banks’ capital adequacy ratio (CAR).

Meanwhile, NBFCs will also benefit as banks would be able to extend more loans to these entities, helping them deal with their liquidity issues.

In a separate circular, RBI also announced that it has excluded microfinance loans from higher risk weights, which are currently applicable to consumer credit.

Bank risk weights for loans extended to microfinance companies will be 75% or 100%, depending on the loan's nature, compared with 125% earlier. All these new risk weight norms come into effect from April 1, 2025.

What is risk weight and its significance?

In November 2023, RBI increased the risk weight of banks’ exposure to consumption loans, credit card loans, and loans given to NBFCs by 25% to 125% to address the sharp hike in unsecured lending.

Risk weight is essentially a number that determines the minimum amount of capital that a financial institution needs to hold to cover its credit risk. In case the borrower fails to repay the loan, the amount set aside as the risk weight helps the lender to deal with the loss of a particular asset and maintain financial stability.

Different kinds of loans are assigned different risk weights because they pose different levels of risk. Secured loans, like mortgage loans, carry lower risk weights because they are backed by collateral, while unsecured loans, like personal loans, carry higher risk weights.

The easing of risk weight requirements would help banks set aside lower capital to cover risk. This would free up some of their reserves and boost their capital adequacy ratio (CAR), which helps assess a bank’s financial health and ability to withstand economic downturns.

How will NBFCs, microfinance institutions going to benefit?

Lower risk weight on bank loans extended to NBFCs and microfinance institutions (MFIs) will encourage banks to lend more to these entities.

This is likely to improve credit flow to NBFCs and MFIs, which will further flow down as improved credit availability in the retail segment of the economy.

This development is especially significant for MFIs, as recent data showed that the gross loan portfolio in the microfinance segment shrunk by 3.5% year-on-year to ₹3.85 lakh crore during the December 2024 quarter due to curtailed funding. Sequentially, the sector's loan portfolio declined from ₹4.08 lakh crore in the September 2024 quarter.