India's tougher consumer credit norms address emergent risk: Fitch

The Reserve Bank of India's recent moves requiring banks and non-bank financial institutions (NBFIs) to allocate more capital against unsecured consumer credit will constrain loan growth in the segment, according to Fitch Ratings.

This should also reduce the potential for the rising appetite for such lending to weaken financial system stability, the credit rating agency says.

"We generally view the tightening as a credit-positive effort by authorities to control emergent systemic risks posed by consumer credit, which has increased rapidly in recent years off a relatively low base," says Fitch.

Growth in banks' unsecured credit card loans and personal loans in the first half of the financial year ending March 2024 stood at 29.9% and 25.5% year-on-year, respectively, against total system-loan growth of 20%. NBFI growth has shown a similar trend.

"We believe increasing exposure to unsecured consumer credit - typically a riskier loan category - indicates greater risk appetite, as banks and NBFIs seek to protect net interest margins (NIMs) amid stiff competition for secured retail loans," the ratings agency says.

The higher risk weightings for banks and NBFIs are generally aligned, although NBFIs will maintain a lower risk weight for credit-card lending (125%, from 100% previously, against 150% for banks) and microfinance will be excluded from higher risk weights for NBFIs, unlike for banks.

The directive restores pre-pandemic risk weights for banks' personal loans. "We estimate the measure may lower the banking system's common equity Tier 1 (CET1) ratio by around 30bp, ranging from 6bp to 34bp for Fitch-rated banks. We believe the basis-point impact will be in double digits for the private banks, State Bank of India and Canara Bank," says Fitch.

"We estimate that the effect of higher risk weights on banks' loans to NBFIs may be significant, averaging about 34bp, while that of higher credit-card risk weights should be lower, at around 5bp. State banks tend to have lower exposure to credit cards but more appetite for lending to NBFIs, a pattern that is broadly reversed for private banks. Overall, we estimate the banking system's CET1 ratio will fall by 60bp-70bp from the impact of the changes," the ratings agency says.

Private banks, which have relatively better CET1 capitalisation than state-run banks, should continue to have reasonable capitalisation after the change and are better positioned to source fresh capital if needed, given their higher price-to-book valuations. "We believe the measures by themselves are unlikely to lower banks’ capital scores or standalone Viability Ratings (VRs), although SBI’s VR headroom may narrow. The measures should reduce the risk of adverse impacts linked to sustained declines in core capital buffers amid high loan growth and risk addition over the medium term," it says.

The affected categories, including consumer credit, credit cards and top-up loans on vehicles, are major lending areas for some NBFIs, such as Bajaj Finance and SBI Card, according to Fitch. "We estimate NBFIs' bank funding costs could rise by 40bp-60bp, assuming banks' capital costs from higher risk weights on loans to NBFIs are fully passed on, adding to our expectation for modest NIM compression."