Rise in unsecured loans and tightening Risk management norms

Context: Indian banks have seen a sharp rise in unsecured loans — mostly personal loans and credit cards. Over the last couple of years, growth in retail credit has been close to 30% which is higher in comparison to 12-14% of credit growth in other segments. 

In the process of credit creation, banks disburse various types of loans like retail loans(vehicle loans or credit card loans), business loans and loans to government(G-secs). The loans disbursed or investments made by the bank are considered as its assets. 

However, these loans(assets) are subjected to various types of risks like credit risk, market risk or operational risk. Hence, these assets are attached with a risk weight for the sake of calculating minimum capital requirements for the bank.

As per BASEL-III norms, RBI mandated all the scheduled commercial banks to maintain a minimum Capital of 9% of their total risk weight assets. 

Capital Adequacy Ratio = Total capital (Tier 1 + Tier 2) / Risk weight assets

How risk weight assets are calculated?

Category of assetAsset Value (Credit Exposure)Risk Weight (%)Risk Weighted Asset
G-sec20000%0
Credit card loan1000125%1250
Education loan5000100%5000
Housing loan700075%5250
Total Asset = 15000Total Risk Weighted asset = 11500

RBI’s latest norms on Risk weights:

  • The RBI increased the risk weights for consumer credit exposure of commercial banks and NBFCs personal loans, by 25 percentage points to 125%. Housing loans, education loans, vehicle loans are excluded from this hike.
  • The RBI also increased the risk weights on banks’ exposures to NBFCs by 25 percentage points.
  • All top-up loans extended by banks and NBFCs against movable assets which are inherently depreciating in nature, such as vehicles, should be treated as unsecured loans for credit appraisal, prudential limits and exposure purposes.

Practice MCQ:

Q)  Which of the following statements about risk weight asset calculations in India is/are true?

  1. Investments in G-secs do not carry any risk.
  2. Risk weight asset cannot be more than the value of the asset.

Select the correct answer using the code given below:

  1. Only 1
  2. Only 2
  3. Both 1 and 2
  4. Neither 1 nor 2

Answer: a

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