RBI’s new credit rules: tighter norms, higher costs for banks

RBI tightens credit norms

The Reserve Bank of India has released a new credit framework that significantly tightens the rules for how banks lend. The changes, detailed in a circular issued last week, focus on provisioning requirements and risk weights for various loan categories, especially unsecured retail credit.

Bankers say the new norms will force lenders to set aside more capital against every rupee lent. This is likely to make borrowing more expensive for consumers and small businesses.

Unsecured loans in the crosshairs

The central bank’s move targets the fast-growing unsecured loan segment, including personal loans and credit card outstandings. Under the new rules, risk weights on these loans have been increased by 25 percentage points.

That means for every Rs 100 lent on a personal loan, a bank must now hold more regulatory capital. This directly raises the cost of funding for banks and, in turn, the interest rate charged to borrowers.

According to the circular, the higher risk weights apply to all new unsecured loans disbursed after the notification date. Existing loans will be phased into the new regime over the next two quarters.

Impact on banks and NBFCs

The new framework will hit non-banking financial companies (NBFCs) hardest. Many NBFCs rely heavily on unsecured lending and have thinner capital buffers than banks.

Analysts tracking the sector estimate that the average tier-1 capital ratio for NBFCs could drop by 50-80 basis points under the new norms. This could force them to raise fresh capital or slow down lending growth.

For banks, the impact is more moderate but still significant. Public sector banks with large retail loan books will see their capital adequacy ratios shrink. Private banks with a focus on high-yield unsecured lending will also feel the pinch.

Higher rates ahead for borrowers

The RBI’s tightening is a deliberate attempt to cool down credit growth, which has been running at around 16% year-on-year. The central bank has repeatedly warned about the build-up of systemic risk in the retail lending space.

With higher capital costs, banks are expected to pass on the burden to customers. Personal loan rates, which currently range between 10.5% and 14%, could rise by 50-100 basis points over the next few months.

Credit card interest rates, already among the highest in the market, are also likely to inch up. Small business loans, often linked to credit scores rather than collateral, may see similar hikes.

What this means for the economy

The new credit playbook is part of a broader regulatory push to ensure financial stability. By making unsecured lending more expensive, the RBI hopes to discourage reckless borrowing and prevent a future spike in bad loans.

However, the immediate effect will be a slowdown in credit disbursal. Sectors like consumer durables, travel, and small retail trade, which depend on easy credit, may see demand cool off.

The RBI has given banks until the end of the current financial year to fully comply with the new norms. Market observers will closely watch how lenders adjust their product pricing and loan approval rates in the coming months.