Central Idea

The Reserve Bank of India (RBI) recently raised risk weights for unsecured loans, including credit cards, consumer durable loans, and personal loans.
Risk weights for bank lending to non-banking finance companies (NBFCs) serving this segment were increased to 125% from the existing 100%.

What are Risk Weights?

Capital Implication: Every rupee lent by a bank has an impact on its capital position.
Attribution to Risk: Risk weights are assigned to loans and assets based on their nature and associated risk.
Capital Coverage: Banks must ensure that their capital is sufficient to cover these risk-weighted assets.
Varying Risk Weights: Different asset classes have varying risk weights. For example, home loans may have risk weights ranging from 50% to 75%, while corporate loans are assigned 100% risk weight.

Interest Rates: Lower risk weights result in lower interest rates for borrowers. This principle guides the pricing of loans.
Examples: Home loans generally have lower interest rates due to their lower risk weights, while personal loans and credit cards carry higher interest rates due to their risk profile.

Rising Share: Unsecured loans have seen rapid growth, constituting 10% of the banking system’s portfolio.
Fastest-Growing Segment: This segment has been the fastest-growing in recent years.
Unsecured Nature: Loans like consumer durable loans lack income-generating assets, making it challenging to ascertain borrowers’ true repayment capacity.
Granular Nature: While small-ticket in nature, the significant growth in this segment has raised regulatory concerns.