By Finacial Services Division (firstname.lastname@example.org)
The RBI’s Statement on Developmental and Regulatory Policies dated February 1, 2019 proposes that henceforth, bank lending to NBFCs will be risk-weighted based on the Basel II risk weights, based on the rating of the NBFC in question. This facility was earlier available only to asset finance companies, and has now been proposed to be extended to all NBFCs, excluding core investment companies (CICs). The likely impact of this new dispensation may be to encourage banks to lend to NBFCs other than the asset finance companies, such as those focusing on loans against properties, personal loans, or loans other than to productive assets. This measure may be aimed at easing the present liquidity strain affecting the NBFC sector, though, it is not sure whether the lower risk weight itself will be a strong motivator for banks to consider lending to NBFCs.
Existing regime: lower risk weight in case of asset finance companies
Basel II norms provide for risk weights based on ratings, whether external or internal ratings, based on the approval received by the bank for its risk management systems. At the highest level of rating, that is, AAA, the risk weight may be as low as 20%, moving up to 50% in case of A-ratings.
Currently, the benefit of risk weighting based on ratings is applicable only in case of asset finance companies as per Master Circular-Basel III Capital Regulations dated July 1,2015. That is to say, in case of all other NBFCs, such as loan companies, the risk weights are 100% irrespective of the rating of the borrower NBFCs.
It is seen that this puts a burden on the regulatory capital of the lending banks, who may, as it is, facing strain on regulatory capital after introduction of Basel III norms and consequential increase in capital requirements.
Proposed extension of the ratings-based risk weights
Under extant guidelines on Basel III Capital Regulations, exposures/claims of banks on rated as well as unrated Non-Deposit Taking Systemically Important Non-Banking Financial Companies (NBFC-ND-SIs), other than Asset Finance Companies (AFCs), Non-Banking Financial Companies – Infrastructure Finance Companies (NBFCs-IFC) and Non-Banking Financial Companies – Infrastructure Development Fund (NBFCs-IDF), have to be uniformly risk-weighted at 100%. With a view to facilitating flow of credit to well-rated NBFCs, it has now been decided that rated exposures of banks to all NBFCs, excluding Core Investment Companies (CICs), would be risk-weighted as per the ratings assigned by the accredited rating agencies, in a manner similar to that for corporates. Exposures to CICs will continue to be risk-weighted at 100%.
Impact of the new regime
- A lower risk weight puts lesser burden on a bank’s regulatory capital. For instance if a bank gives a facility of Rs 100 crores to a AAA-NBFC, the risk weighted exposure, on external ratings, will only be Rs 20 crores, and therefore, the Tier 1 capital requirement will be computed on that number.
- This dispensation will help non-asset finance NBFCs. Asset finance company (AFC) classification is applicable only to those NBFCs whose assets are, at least to the extent of 60%, in productive assets. Productive assets include plant and machinery, transport equipment, construction equipment, etc. Over recent years, major NBFCs have acquired sub substantial exposure in LAPs, corporate loans, working capital loans, personal loans, fintech enabled loans, and so on. These NBFCs may have good ratings too. The new dispensation will help such NBFCs to avail bank loans.
- Generally speaking, in the post-ILFS scenario, banks have become extremely shy of lending to NBFCs and most exposure has now moved to direct assignments and securitisation. The RBI move is a positive signal –it will give a new confidence to banks and encourage them to lend to NBFCs. Whether the NBFC is highly rated or not, the symbolic significance of the move is of great value.