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Reduction of risk weights on bank loans to NBFCs 

Sentimentally positive but will lead to a marginal reduction in CoB for NBFCs

* On 25th Feb’25, the RBI issued a circular addressed to all Scheduled Commercial Banks (SCBs), including Small Finance Banks (SFBs), restoring the risk weights on their exposures to NBFCs, which will now be according to the external rating. This change will take effect from 1 st Apr’25.

* Following the increase in risk weights on bank loans to NBFCs in Nov’23, banks began rationing credit to NBFCs. At the same time, NBFCs (based on RBI’s directions), started diversifying their liability mix towards debt capital markets and ECBs. With the reduction in risk weights, banks are expected to be more forthcoming in extending credit to even some lower credit-rated NBFCs. Therefore, we view this reduction in risk weights as sentimentally positive for the NBFC sector.

* In Nov’23, when RBI increased the risk weights on bank loans to NBFCs, most AAA/AA+ credit-rated NBFCs were able to negotiate (or push back) interest rate hikes on their existing bank borrowings. For incremental non-PSL bank borrowings, interest rates increased by 10-25bp (in the wide spectrum of AAA to A-rated NBFCs).

* It is important to note that bank loans to HFCs and loans to NBFCs eligible for PSL classification were excluded from the increase in risk weights. For NBFCs, bank borrowings under PSL did not see any increase in interest rates. Additionally, NBFC-MFIs (like CREDAG) that took bank loans under PSL were not impacted by the increase in risk weights. The increase in interest rates, resulting from the higher risk weights, primarily affected non-PSL bank borrowings, which were predominantly from select PSU banks.

Our view: Sentimentally positive but insignificant impact on earnings

* There are no winners or losers among NBFCs solely based on RBI’s change in risk weights on bank loans to NBFCs. Ideally, every NBFC should benefit from this restoration of risk weights, particularly those with a higher proportion of nonPSL bank borrowings in their liability mix.

* Most large and/or higher credit-rated NBFCs negotiated well with banks and experienced an insignificant increase in their overall cost of borrowings when risk weights were increased. With the restoration of risk weights effective from Apr’25, NBFCs are unlikely to see significant benefits in their CoB. Benefits (if any) on non-PSL bank borrowings will be 10-15bp, potentially leading to a 2- 5bp decline in the overall borrowing costs for AAA/AA-rated NBFCs. This would translate into an insignificant 0.5%-1.0% increase in earnings for these NBFCs due to the reduction in the cost of borrowings.

* While the impact on CoB and earnings itself is insignificant, NBFCs like CIFC, LTFH, MUTH, and MGFL, which have a relatively higher (compared to peers) proportion of non-PSL bank borrowings, could benefit (albeit marginally) more than their peers.

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