RBI Reduces Risk Weight on Microfinance Loans and Bank Financing to NBFCs: A Regulatory Overview

 

RBI Reduces Risk Weight on Microfinance Loans and  Bank Financing to NBFCs: A Regulatory Overview
By Abhishek Jat, Advocate

 

The Reserve Bank of India (RBI) has recently announced significant regulatory adjustments aimed at easing the risk weight requirements for microfinance loans and bank exposures to Non-Banking Financial Companies (NBFCs). These changes, introduced through two separate circulars dated February 25, 2025, mark a pivotal shift in the regulatory landscape, particularly for the microfinance sector and the broader financial ecosystem.

Revisions in Risk Weights for Microfinance Loans

In November 2023, the RBI had increased the risk weight on consumer credit, including personal loans, to 125%. However, certain categories such as housing loans, education loans, vehicle loans, and gold-backed loans were exempted from this hike. Following a comprehensive review, the RBI has now decided to recalibrate the risk weights specifically for microfinance loans.

Under the new guidelines, microfinance loans classified as consumer credit will now attract a 100% risk weight for commercial banks, including Small Finance Banks (SFBs). This is a notable reduction from the earlier 125% risk weight, which was seen as a deterrent to the growth of the microfinance sector. Notably, Regional Rural Banks (RRBs) and Local Area Banks (LABs) will also benefit from this revised risk weight of 100% for their microfinance loan portfolios.

Additionally, microfinance loans that do not fall under the consumer credit category and meet the Basel III criteria may be classified under the Regulatory Retail Portfolio (RRP), provided that banks have robust policies and procedures in place. This move is expected to incentivize banks to expand their microfinance lending while maintaining prudent risk management practices.

The revised risk weights are applicable to both new and existing microfinance loans, effective immediately from the date of the circular. This regulatory easing is anticipated to enhance credit flow to the microfinance sector, which plays a critical role in financial inclusion and economic empowerment, particularly in rural and underserved areas.

Restoration of Original Risk Weights for Bank Exposures to NBFCs

In another significant development, the RBI has decided to restore the original risk weights for Scheduled Commercial Banks (SCBs) exposures to NBFCs. This decision comes after the RBI had previously increased the risk weights on such exposures by 25 percentage points in November 2023, provided the existing risk weight based on the NBFC’s external rating was below 100%.

Under the revised framework, the risk weights for SCBs’ exposures to NBFCs will once again be determined based on the external ratings of the NBFCs, as outlined in the Master Circular on Basel II Capital Regulations dated April 1, 2023. This restoration is expected to provide relief to NBFCs, which have been grappling with higher borrowing costs due to the increased risk weights.

The revised risk weights will come into effect from April 1, 2025, giving banks and NBFCs adequate time to adjust to the new regulatory environment. This move is likely to foster greater collaboration between banks and NBFCs, thereby strengthening the overall financial system.

Implications and Way Forward

The RBI’s decision to reduce risk weights on microfinance loans and restore original risk weights for bank exposures to NBFCs reflects a balanced approach to regulatory oversight. By easing the capital requirements for microfinance loans, the RBI aims to bolster the sector’s growth, which is crucial for achieving financial inclusion and supporting low-income households.

Similarly, the restoration of original risk weights for NBFC exposures is expected to alleviate the cost of funds for NBFCs, enabling them to play a more active role in credit intermediation. These measures collectively underscore the RBI’s commitment to fostering a resilient and inclusive financial ecosystem.

As the regulatory changes take effect, stakeholders in the banking and financial services sector will need to align their strategies with the revised norms. For microfinance institutions and NBFCs, this presents an opportunity to expand their reach and impact, while banks will need to recalibrate their risk management frameworks to accommodate the new risk weight structures.

In conclusion, the RBI’s latest regulatory adjustments are a welcome step towards creating a more conducive environment for credit growth and financial stability. As the financial landscape continues to evolve, such proactive measures will be instrumental in addressing the challenges and opportunities that lie ahead.