Credit positive unsecured bank loan risk weight is higher: Moody’s

According to Moody’s Investors Service on Monday, the RBI’s move to tighten guidelines for unsecured personal loans is credit positive since it would force lenders to set aside more capital for these loans, enhancing their capacity to absorb losses.

Last week, the Reserve Bank increased risk weights by 25 percentage points for credit cards, unsecured retail loans, and lending to non-banking financing firms (NBFCs).

According to Moody’s, the amount of unsecured loans has increased significantly over the last few years, putting financial institutions at risk of an abrupt rise in credit costs in the event of an interest rate or economic shock.

As a result of lenders having to put aside more money for these loans, they will be able to strengthen their loss-absorbing buffers and maybe reduce their hunger for expansion, according to a statement from Moody’s.

India’s unsecured lending market has reportedly become very competitive over the last several years, with banks, NBFCs, and financial technology (fintech) firms—including a number of recent entrants—aggressively expanding loans in this category.

According to Moody’s, over the previous two years, average increase in personal loans was around 24%, while average growth in credit card loans was 28%. In contrast, the total growth in credit for the banking industry was approximately 15%.

According to Moody’s, “we expect banks would be able to absorb higher risk weights on their capital because the sector’s overall capitalization is at historically high levels with a Common Equity Tier 1 ratio of 13.9% as of March 2023 and the overall banking sector’s exposure to unsecured retail credit is small at around 10% of loans as of September 2023.”

It also said that the effect of the new underwriting guidelines may differ for each institution based on their exposure to unsecured loans.

The RBI’s move to tighten guidelines for unsecured consumer loans is expected to reduce banks’ capital adequacy by 60 basis points, according to a report released last week by US-based S&P Global Ratings.

It also said that the action may result in higher lending rates, slower credit growth, and a greater need for capital raising among weak institutions.