S&P Global Ratings has responded to the recent regulatory actions of the Reserve Bank of India (RBI), predicting a decline of 60 basis points in the Tier-1 capital adequacy of Indian banks.
According to S&P Global Ratings, these actions include a substantial increase in risk weights on unsecured personal loans, credit cards and loans to non-banking financial companies (NBFCs), aimed at curbing riskier lending practices and strengthening overall financial stability.
RBI’s move is expected to have significant ramifications, affecting loan growth, lending rates and capital adequacy, especially for weaker lenders.
Geeta Chugh, credit analyst at S&P Global Ratings, suggests that while these changes may lead to immediate challenges such as higher interest rates and reduced profitability, the long-term impact is likely to be positive, contributing to a more robust and resilient economy. banking system.
Chugh said, “Slower loan growth and increased emphasis on risk management are likely to support asset quality in the Indian banking system. However, the immediate impact is likely to be higher interest rates for borrowers, slower loan growth for lenders reduced capital adequacy, and some hit profits”.
Chugh added, “We estimate that Tier-1 capital adequacy of banks will decrease by around 60 basis points. Financial companies will be worse affected as their incremental bank borrowing costs will increase, apart from the capital adequacy impact.”
Chugh notes that the increased risk weights are a sensible measure, especially in response to the rapid increase in unsecured retail loans, including personal loans and credit card debt.
The risk weights on these loan categories have been increased by 25 percentage points, reflecting the RBI’s concern about the possible accumulation of imbalances, especially in the case of smaller loans.
The rating agency emphasizes the importance of these regulatory measures to support asset quality, given the growth of unsecured retail loans, which grew by 26 percent in the 12 months ending September 2023.
The focus on risk management and a more cautious approach to lending is expected to address concerns about non-performing loans (NPLs) and ensure the stability of the banking sector.
S&P Global Ratings estimates that banks’ Tier-1 capital adequacy will decrease by approximately 60 basis points due to these regulatory changes.
Finance companies are expected to face a more pronounced impact, with higher borrowing costs adding to the challenges posed by the capital adequacy adjustments.
Importantly, the rating agency clarifies that these regulatory adjustments will not have an immediate impact on the credit ratings of Indian financial institutions.
The risk-adjusted capital ratio for rated banks and finance companies will also remain unaffected. The risk weights applied are consistent with global standards, reflecting S&P Global Ratings’ view of risks associated with underlying asset classes.
S&P Global Ratings emphasizes the prudence of the RBI’s move, especially in addressing the growth in unsecured retail loans, which represented about 9.8 percent of total loans in the Indian banking system in September 2023.
The focus on risk management and the need for capital adequacy will be crucial to ensure the stability and resilience of the financial sector amid evolving economic conditions.
Although the regulatory measures are expected to bring short-term challenges, they are in line with a global trend towards more cautious lending practices and enhanced risk management.
As India grapples with the effects of the COVID-19 pandemic and strives for economic recovery, such regulatory interventions play a crucial role in maintaining the stability and integrity of the financial system.