RBI’s risk weight increase to hurt MSME loans-

RBI’s risk weight increase to hurt MSME loans?

By Tashwinder Singh

The increasingly ambitious Indian public is shedding its historic inhibitions, now more than ever, towards availing consumer credit to fuel its lifestyle aspirations. The lending institutions have responded accordingly to meet this surge in credit demand. Nonetheless, RBI, vigilant about potential stress stemming from unanticipated corners, has viewed this trend suspiciously. RBI Governor Shaktikanta Das, in his statement dated October 6, 2023, called for alert risk management and robust underwriting standards regarding certain components of personal loans.

The straightforward implication of the increased risk weights is that given a particular amount of capital, the NBFCs would need to limit their consumer credit portfolio. Further, the circular could necessitate increased capital requirements for the NBFCs and quite possibly, lead to an increase in the cost of capital to fund the consumer credit portfolio of the NBFCs.

These fears have been communicated by the Finance Industry Development Council (FIDC), a representative body of NBFCs, to the Reserve Bank of India, though the FIDC has, otherwise welcomed the move of imposing greater risk weights on consumer loans. Fearing that such a measure has the potential to sharply reduce credit flow to MSMEs and self-employed sections of the public, FIDC has requested that the measure regarding risk weight to bank loans to NBFCs be rescinded.

The key driver of the circular is RBI’s unease with “consumer credit”. While the circular has not clearly defined the term, we could draw guidance from the RBI’s circular on XBRL Returns – Harmonization of Banking Statistics dated January 4, 2018. Viewed in this light, consumer credit connotes exposure to an individual and consists of consumer durable loans, credit card receivables, auto loans, loans against gold, immovable property, fixed deposits, securities, etc. and loans given for other consumption purposes.

The categories of loans not included within “consumer credit” are education loans, loans for the acquisition of immovable property, consumption loans given to farmers under Kisan Credit Card Scheme and loans given for investment in financial assets. Hence, the concept of “consumer credit” is tied to the constitution of the borrower, who essentially must be an individual and to the purpose of application of the proceeds of the credit facility.

Where, then, does this circular leave MSME loans?

It is no secret that MSMEs play a very crucial role in the economy of the country, by providing employment, promoting exports, and as an expression of the entrepreneurial spirit of a large chunk of our population. Consequently, any regulatory directive on the MSMEs has an impact on the entire national economy. In large part, MSMEs, lacking access to capital markets for funding, are reliant on RBI-regulated entities for their debt finance needs. RBI incentivizes grants of MSME loans by classifying bank loans to NBFCs for onward lending to MSMEs of an amount up to Rs 20 lacs as “priority sector loans”.

By their nature, MSME loans are granted to enterprises and not to individuals. The purpose of such loans is to meet business-related needs and expenses and to meet working capital expenditure. Given the meaning of “consumer credit” discussed, it appears that the regulatory measures relating to increased risk weights are not intended to and therefore, do not impact the MSME loans.

The essential element of consumer credit, which is the application of the proceeds of the loans towards activities that do not, in themselves, generate income, runs contrary to the concept of MSME credit. The element of consumption is missing in the MSME loans and thus, MSME loans stand outside the bounds of “consumer credit”. Further, it is crucial to note that the increased risk weights applicable to exposures of scheduled commercial banks to NBFCs do not apply where such exposures can be categorized as “priority sector”. Therefore, loans of scheduled commercial banks to an NBFC to lend an amount of up to INR 20 lacs to an MSME would not be subject to increased risk weights, on account of the categorization of such exposures as “priority sector”.

In conclusion, it appears that RBI, scarred by its past experiences, prefers to err on the side of caution concerning consumer credit. In my opinion, the same cynicism does not carry over to business loans, what with RBI’s stated objective of supporting the growth of the economy. What would have bolstered this point of view is the blanket exclusion of bank loans to NBFCs for on-lending to MSMEs from the purview of the circular. The nuanced approach followed by RBI reflects the central bank’s commitment to steering India’s economic future trajectory with the wisdom gained from historical lessons.

Tashwinder Singh is the CEO and Managing Director of Niyogin Fintech. Views expressed are the author’s own.

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