Rollback Of Lending Curbs Unlikely To Benefit NBFCs, MFIs Instantly, Says Fitch

The Reserve Bank of India's decision to reverse its November 2023 risk-weight norms for bank lending to non-banking financial companies and microfinance institutions is unlikely to result in a rapid increase in bank funding for these sectors, according to Fitch Ratings.

“The RBI regulatory easing could alleviate some pressure on the NBFI and microfinance sectors, but banks are likely to maintain a cautious lending stance due to broader sector liquidity constraints and their focus on risk and funding costs,” the global rating agency said.

In November 2023, the RBI imposed a 25% incremental risk weight on bank loans to NBFCs and MFIs to temper overheated retail lending. Consequently, bank credit growth to NBFCs slowed from 19% in November 2023 to 6.7% by December 2024.

Indian banks' loan growth also slowed to around 11% on year as on December 31, from slightly over 15% at the end of the previous financial year.

As per the rating agency’s estimates, the changes will benefit banks’ regulatory capital ratios by about 30 basis points.

Fitch expects larger NBFCs to renegotiate their funding spreads from banks after the RBI’s move, but the effects may not extend as broadly to the rest of the sector.

“Small and mid-sized NBFIs that are more heavily dependent on bank funding may only benefit if banks increase their appetite for higher-risk lending, which we think is unlikely.” Fitch said.

Fitch believes that Indian banks' appetite to lend to microfinance institutions may be tempered by asset-quality challenges, including in microfinance lending, especially for the mid- to small-sized private banks that are active in this segment.

In January, the rating agency had said that due to increasing stress in Indian banks' unsecured retail loan portfolios, new bad loans in 2024-25 and the following year to be around 25% higher than in 2023-24.

Fitch said there may be some lending opportunism among banks for higher margins, but it may not lead to any meaningful changes in risk appetite given the banks' focus on controlling risk density and managing stretched loan-to-deposit ratios amid prevailing system liquidity issues and rigid deposit costs.