The Reserve Bank of India (RBI) has taken a significant step to boost credit growth by reducing the risk weight for banks on loans to NBFCs and microfinance institutions. This decision is expected to encourage banks to lend more to NBFCs, especially after credit flow from banks to NBFCs saw a sharp decline — from 18.9% to 6.7% — by December 2024.
This move will provide relief to NBFCs and help revive the sector. Additionally, it will support overall economic growth by increasing credit availability. But what does this decision mean for NBFCs, banks, and the economy? Let’s understand.
What’s Happening?
The RBI has reversed the 25-percentage-point increase in risk weights on bank loans to Non-Banking Financial Companies (NBFCs). This means that, as before, risk weights will now be based on external credit ratings. According to an RBI circular issued on February 25, 2025, the change will take effect from April 1, 2025.
Microfinance loans classified as consumer credit will no longer be subject to the higher risk weights announced earlier in 2023. Instead, they will now carry a risk weight of 100%, down from 125%, according to the RBI. Additionally, the risk weight on microfinance loans issued by banks — those qualifying under the regulatory retail portfolio — will be reduced to 75%.
Bank lending to NBFCs dropped sharply from 18.9% in November 2023 to 6.7% in December 2024.
This significant move follows the RBI’s decision in November 2023 to raise risk weights, which led to a slowdown in bank credit to NBFCs. By reversing this measure, the RBI aims to revitalise the sector and strengthen overall credit growth in the economy.
Why Does Risk Weight Matter?
Risk weight is crucial for banks as it determines the amount of capital they must hold for lending. A higher risk weight means banks need to set aside more capital, making loans more expensive, whereas a lower risk weight frees up capital, making lending easier.
For NBFCs, a lower risk weight means banks can extend credit more easily, improving liquidity and enabling NBFCs to expand their lending activities. This, in turn, boosts credit availability across the economy, driving spending, investment, and growth.
What Does This Mean for Investors?
The slowdown in bank lending to NBFCs could ease with the RBI’s latest move. This decision will improve liquidity for NBFCs, enabling them to expand their lending activities. Not only will it increase potential revenue, but it will also drive profit growth. With easier access to funds, NBFCs can offer more loans to retail customers, leading to higher earnings.
Better credit availability will allow NBFCs to reach underserved markets and tap into new opportunities, fostering business expansion and potentially driving stock prices higher.
NBFCs such as Bajaj Finance, Shriram Finance, Aditya Birla Capital, and Cholamandalam are likely to benefit from this move. Additionally, in the microfinance sector, IndusInd Bank is expected to gain, while Bandhan Bank, a major micro-lender, could see an improvement in its capital ratios.
What’s Next?
The RBI’s decision to restore lower risk weights is expected to provide much-needed relief to NBFCs with strong credit ratings. This move will help improve liquidity, facilitate greater credit flow across the sector, and support overall economic growth. Additionally, NBFCs may benefit from lower borrowing costs as banks reduce lending rates, passing on the savings from lower capital requirements.
However, despite some improvement, banking system liquidity remains tight, with an estimated deficit of Rs 1.5 trillion as of February 20, 2025. While the RBI’s measures — such as the reduction in the policy repo rate and open market operations — have helped ease conditions slightly, continued support will be crucial for sustaining credit growth and economic expansion.
*The companies mentioned in the article are for information purposes only. This is not an investment advice.
*Disclaimer: Teji Mandi Disclaimer
