RBI's post-Diwali retail loan dampener – will higher risk weights hurt spending?

While the impact of the RBI’s latest measures on overall consumption is unclear, the already hurting consumer durables segment could come under pressure.

Trust the Reserve Bank of India (RBI) to have a good sense of timing. Days after the festive season peaked with Diwali, the central bank on November 16 announced measures to curb the growth in retail loans, asking banks to set aside greater amounts of capital for personal loans, excluding a few categories such as for housing, education and vehicles, among others. A similar increase was announced for credit card loans.

For non-banking financial companies (NBFCs), it was a double whammy, with both their asset and liability sides being affected. Not only did the RBI increase the risk weights on banks' exposure to NBFCs – effectively hiking shadow banks' cost of funds – it also raised the risk weights on their unsecured loans.

The immediate impact of these measures is already visible, with shares of companies such as SBI Cards, Bajaj Finance, HDFC Bank and ICICI Bank falling as much as 6 percent at one point on November 17. But the RBI will have its eye on the medium-term impact.

Higher rates, reduced spending?

An increase in risk weights means higher capital requirements, which should lead to higher interest rates on these types of loans. NBFCs, which will see an increase in their cost of funds, will try and pass on this increase to their borrowers. The natural result of these higher borrowing rates should be reduced growth in personal loans and, in turn, a fall in spending.

However, a couple of important caveats are necessary.

One, while the business of NBFCs may see a slowdown due to the increase in their cost of funds, banks are well capitalised. As such, the revised risk weights should not prove to be a hurdle when it comes to giving these loans. Speaking to CNBC-TV18 earlier on November 17, State Bank of India Chairman Dinesh Kumar Khara noted the same, saying there is sufficient room to support growth going forward.

Banks, though, cannot ignore what the RBI wants.

"Signalling impact is the main driver, as it would force lenders to slow down growth directly or indirectly. We have seen lenders tightening their credit filters in recent months and this guideline for the regulator would only sharpen their efforts," Kotak Institutional Equities said in a note.

The second reason why it is difficult to assess the macroeconomic impact of the RBI's measures are the exclusions. As of September 22, banks' housing, education, and vehicle loans, and loans secured by gold and gold jewellery, amounted to Rs 32.26 lakh crore, or nearly 70 percent of banks' total personal loans. And all four of these were up more than 20 percent year-on-year in September, with housing loan growth at 37 percent.

Loans for consumer durables make up less than half a percent of personal loans, while credit card outstanding amounts to Rs 2.17 lakh crore or 4.5 percent of personal loans. Other personal loans, meanwhile, make up a quarter of all personal loans and were up 25 percent in September over the previous year. As such, the portion of personal loans impacted by the RBI's measures is only about 31 percent or so.

This rate of growth, though, is set to moderate – but not by much.

"Unsecured loan growth may come down, but it will comfortably stay in the double-digit zone. The digitalisation push means it has become extremely easy and convenient to get these loans," said Sanjay Agarwal, Senior Director at ratings agency CareEdge.

Also Read: Fintechs may feel the heat as RBI moves to curb unsecured consumer loans

While borrowing costs may go up, Agarwal isn't sure if there will be any impact on consumption.

"With unsecured loans, there is no way of saying where the money goes. It could be used for investments and the stock market, paying the balance on a home loan, or something else. There is no way to find out how much of it is used for consumption and, therefore, it is difficult to say what will be the impact on it," he added.

Hitting 'em where it already hurts

Consumer durables, however, may face the brunt of the RBI's measures.

"Close to 80 percent of purchases of consumer durables are reported to be through consumer financing schemes spiced up with attractive equated monthly instalment (EMI) offers," the RBI's monthly State of the Economy article said on November 17, published just a couple of hours before the central bank announced the measures.

"Festival spending and consumer exuberance are also driving record loan disbursements by NBFCs. Nearly half of the credit demand is originating from tier-3 cities," the article added.

Also Read: Optimism among businesses, but India's consumption story has cracks

This may spell bad news for India’s consumer goods story, which is already in some trouble. For the first half of 2023-24, production of consumer durables was 0.7 percent lower than in the same six-month period last year, with Nomura's economists saying that the latest industrial production numbers for September, released on November 10, reflect "cracks in consumption story".

Financial stability matters

While flagging the "very high growth" seen in some segments of personal loans on October 6, RBI Governor Shaktikanta Das had said the central bank "will act proactively to maintain financial stability". And by announcing its measures after Diwali, the RBI seems to be looking to minimise the consumption impact even while addressing emerging financial stability concerns.

While the bad loan ratios in the Indian financial system are not an issue, there has been "soft feedback" over the last two to three quarters about the deterioration in asset quality, although it is nothing alarming, CareEdge's Agarwal said.

"The RBI's action is a clear sign that the regulator wants to curb loan growth in these segments," Nomura analysts said on November 17.

After years of single-digit growth, bank credit has surged over the past year and a half or so, driven by unsecured retail loans and bank credit to NBFCs. As per the latest RBI data, gross bank credit was up 20 percent year-on-year in September, although the number is inflated by the recent merger of HDFC Bank and HDFC. Personal loans, meanwhile, were up 30.4 percent, before accounting for the aforementioned merger.

On the whole, the central bank's steps should really be seen from the lens of financial stability. And if the RBI was Dua Lipa, it would be singing 'one default is all it takes'.