RBI as consumer loans watchdog or obstruction

Following many months of telegraphing its continued discomfort with the rapid growth in personal loans and unsecured credit, the Reserve Bank of India (RBI) has issued its most obvious sign of tougher action to come. In its governor’s statement of October 2023, the RBI advised banks and non-banking financial companies (NBFCs) to “strengthen their internal surveillance mechanisms, address the build-up of risks” and to “institute suitable safeguards”. The statement also warned that the RBI “will act proactively to maintain financial stability”.

The RBI must have thought that its previous and increasingly stern warnings did not bring about desired results or even a modicum of caution. The governor’s statement was followed by a circular of 16 November that raised the risk weights for banks on all outstanding and new consumer credits, including personal loans, from 100% to 125%.

Certain categories of loans such as housing loans, education loans, vehicle loans and loans secured by gold and gold jewellery were excluded from this decision. The circular also increased the risk weights for consumer loans provided by NBFCs other than housing loans, education loans, vehicle loans and loans secured by gold and gold jewellery from 100% to 125%. It is perhaps the case that these actions were implemented to minimise regulatory arbitrage and also took into consideration that a large part of the banks’ growth in credit offtake results from loans to NBFCs.

Continuing its toughening of measures over consumer credit, the RBI’s circular also increases the risk weight on loans by scheduled commercial banks to NBFCs by 25% over and above the risk weight assigned by accredited external credit assessment institutions where the applicable risk weight is below 100%.

Loans to housing finance companies and NBFCs that are eligible for classification as priority sector loans are excluded from this amendment. The risk weight on credit card receivables has also been increased to 150% and 125% for banks and NBFCs, respectively.

In a further crackdown on consumer credit, while vehicle loans themselves are not subject to a higher risk weighting, top-up loans secured by movable assets such as vehicles, which are depreciating in nature, are required to be classified as unsecured loans. RBI-regulated entities have also been instructed to review sectoral exposure limits for consumer credit, and for these limits to be “strictly adhered to and monitored on an ongoing basis”.

The RBI’s circular has dampened the growth of consumer loans, forcing consumer loan-oriented lenders and credit card providers to rethink their strategies. This is clearly the consequence that the RBI has sought to bring about. Usually, financial sector regulators, including the RBI, provide some lead time for stakeholders to make arrangements to ensure compliance. However, this direction was introduced with immediate effect, perhaps an indicator of the RBI’s increasing discomfort with the growth in personal loans.

This is not the first time that the RBI has increased the risk weighting on consumer loans. It previously did this in 2004 to 2005, only relaxing such tightening in 2019. With this background, from an economic history perspective this is not so much a new approach as resorting to an old remedy for a possible future ill.

While the circular has resulted in some rumblings of discontent in the financial sector, the overall impression is that lenders in the usual course of the banking business will continue to thrive. However, newer lenders, which are more consumption lending oriented will have to rework their models. The RBI’s view appears to be that while consumer lending is good, it should keep in lock-step with the overall growth of the economy to maintain systemic stability.

Keeping in mind the RBI’s past experience in forcing lenders to clean up their balance sheets because of non-performing loans, its present move can be considered a cautionary one, looking to forestall a situation from becoming an issue. It is perhaps an indication of the hawkish approach of the RBI that while it supports increased consumer spending and growth, this has to be done at a cautious pace and not in an unchecked manner. At the same time, such spending and growth should comply with prudential standards.

Sawant Singh and Aditya Bhargava are partners at Phoenix Legal.