Risk Weights is minimum capital to be maintained before granting a loan.

Suppose a lending institute gives loan of Rs 100 to its customers then this Rs 100 loan has contribution of mainly two components:

1. Contribution from banks capital or equity
2. Contribution from Depositor (Usually higher than Contribution from Shareholder or Equity)

So, in simple words

Amount of Loan Passed = Contribution from Banks capital or Equity + Contribution from Depositor

To protect the depositor’s contribution and to control the Banks from distributing excess loans, RBI notifies Banks to maintain a minimum contribution from capital or equity and not to go below that limit called Risk Weight which can be easily understood by example explained in next section.

For NBFCs & Personal Loans, risk weight increased from 100% to 125% and for Credit cards, risk weight increased from 125% to 150%.

Yes, Risk Weights increase made by RBI covers all present and past outstanding loans.  

After trying to sensitize lenders against excessive growth of unsecured loans and its cons earlier, finally Risk Weights on Consumer Loans increased by RBI to serve following purposes:

• To curb the probable NPAs in future.
• To provide economic stability.
• To safeguard depositor’s money.
• To curb the rapid growth (about 23%) of unsecured loan than usual (about 14%).
• To enforce banks to do proper provisioning and more due diligence before granting loans.

It may lead to make consumer loans costlier as the lending institutions may transfer their burden to end customers. So, consumers may have to pay more EMI for both new and outstanding consumer loans.

Banks and NBFCs are impacted negatively by Risk Weights increase of RBI as it would increase costs of raising extra funds required to grant the loans.

Similarly, end customers will also be impacted negatively as they may have to pay more EMIs on consumer loans.

Risk Weights increase by RBI impacted negatively on Share Price as it would curb the growth of unsecured loans by Banks and NBFCs and also increase the cost of extra fund raising, resulting lesser performance of banks and NBFCs.

Secured loans providers such as Vehicle Loans, Housing Loans, Loans against Property, Jewellery Loans, Education Loans etc will not be impacted by this.

Micro Finance Loans are also exempted by Risk Weights increase of RBI.

Loans which are backed by asset such as Vehicle Loans, Housing Loans, Jewellery Loans, Loan Against Property etc are called Secured Loans.

Loans which are not backed by asset such as Personal Loan, Credit Card, Consumer Loans etc are called Secured Loans.

Risk Weights on Unsecured Loans are higher and Risk Weights on Secured Loans are lower as in case of defaults, secured loans may be recovered easily as they are backed by asset.

The Capital to Risk-weighted Asset Ratio (CRAR), also known as the Capital Adequacy Ratio (CAR), represents a bank’s available capital as a percentage of its risk-weighted credit exposures. Its purpose is to safeguard depositors’ interests and foster the stability and efficiency of financial systems.

The formula for CAR is expressed as Eligible Capital divided by Risk Weighted Asset. According to Basel III norms established by the Bank for International Settlements (BIS), the minimum CAR mandated for banks is 8%. However, under the current guidelines of the Reserve Bank of India (RBI), public sector banks are required to maintain a CAR of at least 12%, while scheduled commercial private banks should aim for a minimum CAR of 9%. Non-Banking Financial Companies (NBFCs) are expected to uphold a CAR of 15%.