Review of Risk Weights on Microfinance Loans
The Reserve Bank of India (RBI) has revised the risk weight framework for microfinance loans, impacting various banking institutions. These changes affect commercial banks, including Small Finance Banks (SFBs), but exclude Regional Rural Banks (RRBs) and Local Area Banks (LABs). The revision aligns with Basel III Capital Regulations and recent regulatory measures concerning consumer credit.
Impact on Commercial Banks and Small Finance Banks
As per para 5.9.1 of the Master Circular on Basel III – Capital Regulations (April 1, 2024), loans that meet the four qualifying criteria in para 5.9.3 may be classified under the Regulatory Retail Portfolio (RRP) and attract a risk weight of 75%. However, consumer credit, including personal loans, is explicitly excluded from RRP classification under para 5.9.2.
In a November 16, 2023, circular, the RBI increased the risk weight on consumer credit (excluding housing, education, vehicle loans, and loans secured by gold) to 125%. Upon review, the RBI has decided to exclude microfinance loans in the nature of consumer credit from this higher risk weight. Instead, such loans will now attract a risk weight of 100%.
Additionally, microfinance loans not classified as consumer credit may still qualify for RRP treatment if they meet all four criteria in para 5.9.3. Banks must implement appropriate policies and standard operating procedures to ensure compliance with these qualifying conditions.
Impact on Regional Rural Banks (RRBs) and Local Area Banks (LABs)
All microfinance loans extended by RRBs and LABs will be subject to a 100% risk weight, without differentiation based on consumer credit classification.
Applicability and Legal Basis
These revised risk weights apply to both outstanding and new microfinance loans from the date of the circular’s issuance. Other regulatory guidelines remain unchanged.
The revised framework is issued under Sections 21 and 35A of the Banking Regulation Act, 1949, empowering the RBI to regulate risk assessment and capital adequacy norms in banking.
Conclusion
This review refines the risk weight treatment of microfinance loans, balancing financial stability with the need for financial inclusion. While commercial banks and SFBs benefit from continued classification under RRP, the increased risk weight for consumer credit-oriented microfinance loans may lead to a reassessment of lending strategies. RRBs and LABs, however, will uniformly apply a 100% risk weight to all microfinance loans, ensuring regulatory consistency.
