Moody’s Endorses RBI’s Tighter Underwriting Norms as Credit Positive
Moody’s Endorses RBI’s Tighter Underwriting Norms as Credit Positive
Moody’s Investor Services has expressed support for the Reserve Bank of India’s (RBI) recent tightening of underwriting norms, stating that it is a credit positive move. This development, which involves higher risk-weighted assets, is expected to encourage banks to allocate more capital for riskier loans, thereby enhancing their loss-absorbing buffers and potentially moderating their growth appetite.
RBI’s Increased Risk Weights on Unsecured Loans
On 16 November 2023, the RBI raised the risk weights on riskier unsecured retail loans and credit cards by 25 percentage points for banks and non-bank finance companies (NBFCs). This change comes in response to the rapid growth of the unsecured lending segment in India, which has seen banks, NBFCs, and fintech companies aggressively expand their loan portfolios in this area.
Growth of Unsecured Lending and Associated Risks
The unsecured lending segment, comprising personal and credit card loans, has grown significantly in recent years. According to Moody’s, personal loans grew by approximately 24%, and credit card loans by 28%, outpacing the overall banking sector’s credit growth of around 15%. This rapid expansion has exposed financial institutions to potential spikes in credit costs, especially in the face of economic or interest rate shocks.
Shift in Lending Focus and Challenges
Many NBFCs, traditionally focused on secured lending categories like infrastructure and vehicle loans, have shifted towards these riskier segments. The net interest margins for such loans are decreasing due to intense competition. Additionally, the collaboration between banks, NBFCs, and fintech companies in sourcing unsecured loans through apps poses risks, as fintechs’ loan origination and collection models are largely untested and could lead to asset quality volatility.
Banking Sector’s Capacity to Absorb Higher Risks
Moody’s expects that banks can absorb the impact of higher risk weights on their capital, as the overall exposure of the banking sector to unsecured retail credit is relatively small, around 10% of loans as of September 2023. Furthermore, the banking sector’s overall capitalization is robust, with a Common Equity Tier 1 ratio of 13.9% as of March 2023.
Differential Impact on Individual Lenders
The impact of the new underwriting rules could vary among individual lenders, depending on their exposure to unsecured loans. Additionally, the RBI has increased risk weights on banks’ exposure to NBFCs selectively, applicable to NBFCs benefiting from risk weights below 100% due to higher domestic ratings. However, Moody’s notes that the strain from higher risk weights will be moderate, as it excludes loans extended for housing finance and priority sectors such as agriculture and micro, small and medium enterprises.
