In a strategic move to stimulate economic growth and enhance credit availability, the Reserve Bank of India (RBI) has revised its regulatory framework concerning bank loans to Non-Banking Financial Companies (NBFCs) and microfinance institutions. On February 25, 2025, the central bank announced a reduction in risk weights assigned to these sectors, effectively lowering the capital reserves banks must maintain for such exposures. This policy adjustment aims to encourage banks to increase lending to NBFCs and microfinance entities, thereby facilitating greater financial inclusion and support for underserved segments of the economy.
Background of Regulatory Changes
In November 2023, the RBI had increased risk weights on bank loans to NBFCs and microfinance institutions by 25 percentage points, raising them to 125%. This measure was implemented to address concerns over the rapid expansion of unsecured personal loans and potential financial instability. However, this stringent regulation led to a noticeable deceleration in credit flow to these sectors, prompting the RBI to reassess its stance. The recent rollback restores the previous risk weight of 100% for consumer microfinance loans and adjusts the risk weights for bank exposures to NBFCs based on their credit ratings.
Implications for Banks and NBFCs
The reduction in risk weights translates to a decreased capital requirement for banks on loans extended to NBFCs and microfinance institutions. This change is anticipated to incentivize banks to augment their lending activities to these sectors, as they can now allocate less capital against such exposures. For NBFCs, especially those with robust credit ratings, this policy shift is expected to enhance access to bank funding, enabling them to expand their lending portfolios to retail and priority sectors. Anil Gupta, Senior Vice-President of Financial Sector Ratings at ICRA, noted that the restoration of lower risk weights for well-rated NBFCs would improve credit flow from banks to these entities, positively impacting their capital ratios.
Impact on Microfinance Institutions
Microfinance institutions (MFIs) play a pivotal role in providing financial services to low-income populations. The previous increase in risk weights had constrained banks’ willingness to extend credit to MFIs, leading to a contraction in microfinance portfolios. Data from the Microfinance Institutions Network (MFIN) indicated a 3.5% year-on-year decline in the microfinance portfolio, amounting to ₹3.9 lakh crore in the third quarter of FY24. The RBI’s decision to revert to lower risk weights is poised to rejuvenate bank lending to MFIs, thereby bolstering financial inclusion efforts and supporting economic activities at the grassroots level.
Economic Context and Rationale
The RBI’s policy revision comes against the backdrop of a slowing economic growth trajectory and tightening liquidity conditions in the banking system. As of February 20, 2025, the average banking system liquidity was estimated to be in a deficit of ₹1.5 trillion, slightly improving from ₹2 trillion in January 2025. To address these challenges, the central bank has implemented measures such as open market bond purchases and long-term variable rate repo auctions, injecting approximately ₹3.2 trillion into the system. By easing capital requirements for banks on loans to NBFCs and microfinance institutions, the RBI aims to alleviate funding constraints, stimulate credit growth, and, consequently, invigorate economic activity.
Industry Response and Future Outlook
The financial industry has largely welcomed the RBI’s move, viewing it as a positive step toward enhancing credit flow to critical sectors. Ajit Velonie, Senior Director at CRISIL Ratings, highlighted that lowering risk weights will free up banks’ capital, providing a favorable impetus for the overall NBFC sector. This regulatory relaxation is expected to enable NBFCs and MFIs to access more affordable funding, thereby extending their reach to underserved markets and contributing to broader economic development. As banks adjust to the revised norms, a gradual uptick in lending to these sectors is anticipated, fostering a more inclusive financial ecosystem.
Conclusion
The RBI’s decision to lower risk weights on bank finance to NBFCs and microfinance loans marks a strategic shift aimed at revitalizing credit flow to sectors integral to financial inclusion and economic growth. By reducing capital constraints on banks, the policy seeks to encourage increased lending to NBFCs and MFIs, thereby supporting their capacity to serve diverse borrower segments. This move underscores the central bank’s commitment to fostering a balanced and resilient financial system, responsive to the dynamic needs of the economy.