RBI tightens rules for personal loans and credit cards; what does it mean for banks, NBFCs, and customers?

RBI tightens rules on personal loans: Banking and financial services stocks came under pressure in the morning trade on Friday, November 17, after the Reserve Bank of India (RBI) tightened rules for personal loans and credit cards last evening amid a demand surge.

As of 11:43 a.m., Nifty Bank was down 1.02 per cent at 43,710.6, and the S&P BSE Bankex was down 1.10 per cent at 49,363.37 levels.

The Nifty Financial Services index was down 0.61 per cent with SBI Cards being the top loser, which slipped over 5 per cent, followed by Cholamandalam Investment and Finance Company, which dipped over 3 per cent. SBI and Axis Bank slipped over 2 per cent, Bajaj Finance and Shriram Finance were down over 1 per cent and HDFC Bank, ICICI Bank, Bajaj Finserv, and Kotak Mahindra Bank were down between 0.06 per cent and 0.83 per cent.

On the Nifty 50 pack, SBI, Axis Bank, ICICI Bank, and Bajaj Finance were the top losers, slipping between 0.87 per cent and 3.01 per cent.

Last evening, the Reserve Bank of India (RBI) increased the risk weights for banks and non-bank financial companies (NBFCs), or the capital that banks need to set aside for every loan, by 25 percentage points to 125 per cent on retail loans. Risk-weighted assets (RWA) is a banking term that refers to an asset classification system that is used to identify the minimum amount of capital that a lending institution must have to avoid insolvency and protect its depositors and investors.

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The tighter rules, in the form of higher capital requirements, will make such loans costlier.

How analysts interpret the RBI's move

With an increase in risk weights, banks and NBFCs will require a higher amount of capital to balance their profitability. It will also impact the return on equity (RoE).

Global brokerage CLSA, in its note, said that the RBI's move is a double whammy for NBFCs. The brokerage estimates the direct impact of a 40–80 basis point (bps) reduction in Tier I capital for banks and 230–415 bps reductions for Bajaj Finance and SBI Cards, respectively. Further, the risk weight increase will also have a direct impact on the cost of borrowing for NBFCs, it notes.

CLSA also sees an impact on fintech firms like Paytm, although not large.

Echoing similar views, analysts at HSBC note that the pricing of loans to NBFCs and personal loans should go up. It added that the SBI Card will be most impacted.

According to Rahul Malani, an analyst at Sharekhan by BNP Paribas, large banks such as HDFC Bank, ICICI Bank, Axis Bank, and Kotak Mahindra Bank will be impacted most as they have higher cumulative exposure towards these segments, which would result in a reduction of Common Equity Tier 1 capital (CET 1) by 40–60 bps from the September' 23 levels.

Malani added that mid-private banks, RBL, and Bandhan Bank would be impacted relatively more. Other mid- and small private banks, along with public sector banks, would be affected relatively less, as they have lower exposures to these segments, resulting in a reduction in CET 1 capital by 10–30 bps.

Tier 1 capital is a bank's core capital, which it uses to function daily. Common Equity Tier 1 (CET1) is a component of Tier 1 capital. It is "the highest quality of regulatory capital, as it absorbs losses immediately when they occur," according to the Bank of International Settlements.

"A bank’s capital structure consists of Lower Tier 2, Upper Tier 1, AT1, and CET1. CET1 is at the bottom of the capital structure, which means that any losses incurred are first deducted from this tier in the event of a crisis. If the deduction results in the CET1 ratio dropping below its regulatory minimum, the bank must build its capital ratio back to the required level or risk being overtaken or shut down by regulators," explains Investopedia.

How will the move impact customers?

As per Zee Business Research, an increase in risk weight will cause NBFCs to face higher capital requirements, and the cost of funds will also increase, which will be passed on to customers in the form of an increased interest rate.

Karthik Srinivasan, Senior Vice President and Group Head, Financial Sector Ratings, at ICRA Ltd., expressed similar views.

"These announcements are expected to result in a higher capital requirement for the lenders and hence an increase in lending rates for the borrowers," said Srinivasan.

Outlook 

"Historically, we have seen that these events are transitory in nature. We continue to maintain our overweight stance on banks and NBFCs as we find a strong earnings outlook and stocks are available at relatively reasonable valuations," said Sharekhan.

"Banks are well capitalised and we don’t see an impact on banks' growth capital," said Prabhudas Lilladher in a report. "If we see this action taken by the RBI, it is a proactive movement that is positive for banking in the long term. But in the short term, it can hit the margins of banks, NBFCs, and credit card companies," said Vaibhav Kaushik, Research Analyst, GCL Broking.

Kaushik added that credit card companies will be hit most as their costs increase, which will lead to slow growth. On the other hand, banks will have the least effect as their exposure to this is small.

He recommended buying Kotak Mahindra Bank, Federal Bank, and IndusInd Bank shares on dips.

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