RBI's Risk Weight Adjustments
What Changed and Why Does It Matter ?
The Reserve Bank of India (RBI) recently revised risk weights for consumer credit, microfinance loans, and bank loans to NBFCs. These adjustments have significant implications for lending, credit growth, and financial stability. But what exactly are risk weights, why did RBI make these changes, and how do they impact the financial ecosystem? Let's break it down.
1. What is a Risk Weight?
A risk weight is a percentage assigned to different types of assets (mainly loans) based on their perceived risk of default. It helps in calculating how much capital a Bank or NBFC needs to set aside to cover potential losses.
Example:
A government bond may have 0% risk weight (very safe).
A home loan may have 50% risk weight (moderate risk).
A personal loan may have 100% risk weight (higher risk).
The higher the risk weight, the more capital the lender must hold against that asset.
2. Why Do Risk Weights Matter?
Banks lend money and earn interest, but they also need to ensure they have enough capital (equity) to absorb losses if borrowers fail to repay. Regulators use risk weights to prevent excessive lending and ensure financial stability.
3. How is Risk Weight Used in Capital Calculation?
Banks maintain capital under Basel norms, which require a Capital Adequacy Ratio (CAR).
Risk-Weighted Assets (RWA) = Loan Amount × Risk Weight
Example Calculation:
A bank gives a ₹100 crore home loan (50% risk weight).
RWA = ₹100 crore × 50% = ₹50 crore.
The bank must hold capital based on this RWA.
If the risk weight was higher (e.g., 100% for personal loans), the capital requirement would double.
Example for a 100 cr loan book for each loan type (HL , PL, MFI), After further changes in Feb-25, required capital drops to ₹10 Cr for PL & MFI loans.
Notice additional 5 crs lender needs to keep for a 100 cr loan for each loan type.
Lower risk weights free up capital, allowing institutions to expand their loan books without raising additional funds.
4. What Happens When Risk Weights are changed?
When risk weights are increased :
Banks must set aside more capital, reducing lending capacity.
Borrowers may face higher interest rates due to increased capital costs.
When risk weights are reduced :
Banks can lend more with the same capital.
Credit flow increases, benefiting businesses and consumers.
5. The RBI’s 2023 and 2025 Risk Weight Changes
In November 2023, the RBI increased risk weights for certain loan categories to curb excessive credit growth, particularly in unsecured personal loans and microfinance. However, in February 2025, RBI reduced and brought below changes to ensure liquidity and financial inclusion.
6. Reasons For These Changes?
The 2023 increase was meant to curb aggressive growth in unsecured retail loans specifically Microfinance loans and ensure banks and NBFCs maintained sufficient capital buffers. However, this move also tightened liquidity, slowing down credit expansion, especially in microfinance and NBFC sectors.
The 2025 update was aimed at balancing stability with growth:
Supporting financial inclusion by reducing capital costs for microfinance loans.
Ensuring liquidity for NBFCs, which play a key role in lending to underserved segments.
Keeping control over credit card debt, where risk weights remain high to prevent excessive unsecured lending.
7. Impact on Banks and NBFCs
✅ Banks: More lending capacity for personal and microfinance loans, but continued caution on credit card receivables.
✅ NBFCs: Improved access to bank funding, enabling greater credit flow to consumers and businesses.
✅ Microfinance Institutions: Lower capital requirements, allowing more lending to low-income borrowers.
✅ Borrowers: Likely increase in loan availability, particularly in personal loans and microfinance.
Conclusion
RBI’s risk weight adjustments showcase its role in maintaining financial stability while ensuring credit flow. The 2023 tightening helped control risks, while the 2025 reduction promotes economic growth and inclusion. This move reflects RBI’s flexible approach to balancing credit expansion with financial prudence.
What do you think about RBI’s latest policy shift? Will it help the financial sector, or is there a risk of another lending boom? Share your thoughts in the comments!