Risk Weights

Reserve Bank of India (RBI) has increased the risk weight of commercial banks and non-banking financial companies’ (NBFC) unsecured loans from 100% to 125% as a preventive measure against possible NPAs.

Risk Weights – It is the risk associated with every rupee lent by the bank on its capital position.
Risk Asset Ratio System – It was introduced by RBI in 1992 for banks including foreign banks as a capital adequacy measure in line with the Capital Adequacy Norms prescribed by Basel Committee

Capital Adequacy Ratio, known as Capital to Risk (Weighted) Assets Ratio (CRAR) is the proportion of a bank’s capital to its current and risk-weighted liabilities.

Calculation – It depends on the nature of the loan and the inherent risk associated with it.
Role in loan pricing - Lower the risk, lower the rate of interest on the loans provided.
- For instance, home loans have the lowest interest rate among retail products while personal loans and credit cards have the highest interest rate based on their risk profile.
In case of higher risk weights, the lenders must set aside more capital when making loans, thereby lowering their growth potential.
Impact of RBI’s move – The increase in risk weights by the RBI will elevate funding costs for NBFCs and impact capital requirements.
The immediate impact will likely affect lending partners like Paytm.
In the long run, the overall financial system is expected to become more cautious in disbursing unsecured loans thus preventing over-leveraging.

Unsecured loan is a loan provided without any collateral which include credit cards, consumer durable loans and personal loans.

Source:

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