New RBI Norms to Make Personal Loans Costly in 2024

Personal loans, readily available with a good credit score, fulfil diverse needs-from consolidating high-interest debts and offering emergency funds for unforeseen costs to financing significant purchases, covering educational expenses, and even supporting business ventures. Furthermore, the growth of lending apps has resulted in a significant surge in personal loans. Over the past year, the growth of personal loans and credit cards has outpaced the overall bank credit growth, which stands at around 15%.

However, the RBI has raised concerns about the rapid growth in specific segments of personal loans, advising both banks and NBFCs to improve their internal monitoring mechanisms. They are urged to address any accumulating risks and implement appropriate safeguards for their benefit.

Shaktikanta Das, in the October monetary policy, expressed, "Certain components of personal loans are, however, recording very high growth. The Reserve Bank is closely monitoring these areas for any signs of incipient stress. Banks and NBFCs would be well advised to strengthen their internal surveillance mechanisms, address the build-up of risks, if any, and institute suitable safeguards in their own interest. The need of the hour is robust risk management and stronger underwriting standards."

RBI-regulated lenders are obligated to uphold a specific capital proportion corresponding to the loan amounts they extend. The increase in risk weightage means that lenders must now uphold increased capital reserves for loans that are considered riskier. Hence, this will bring about adjustments for the lenders. All regulated entities must adhere to the revised regulations by February 29, 2024, leading to increased expenses associated with unsecured lending.

In November 2023, the Reserve Bank of India increased the risk weights for consumer credit exposure, specifically for personal loans, by 25 percentage points, bringing it to 125 per cent. This implies that banks are now required to maintain a higher amount of capital, leading to an increase in the cost of the capital of these loans.

This signifies that previously, banks were required to maintain Rs 9 in capital for every Rs 100 loaned, but now they must set aside Rs 11.25. This adjustment applies to both existing and new loans, excluding home loans, education loans, car loans, gold loans, and microfinance loans. It is necessary to understand that this adjustment impacts both existing and new loans.

As a result, personal loans are expected to see a rise in costs due to the Reserve Bank of India's regulatory adjustments. NBFCs are encountering challenges due to these rule modifications.

Furthermore, there is a modification in the risk weight assigned to credit card receivables for scheduled commercial banks, which has increased from 125% to 150%. Moreover, non-banking financial companies now face a 25% hike in their risk weights, set at 125% under the revised regulations.

To increase lending, financial institutions must secure more funds from the market. As all lenders are confronted with the same scenario, there will be a surge in demand for new funds, resulting in increased costs. The rise in risk weightage tends to make small-ticket personal loans, especially those offered by NBFCs, more costly for lenders. To counterbalance these expenses, lenders will extend loans at higher interest rates.

Financial institutions, including both banks and NBFCs, with higher exposure to unsecured loans may implement more stringent underwriting standards, making access to personal loans more challenging and time-consuming.

As a result, borrowers might encounter higher interest rates and restricted access to credit as banks adapt their lending practices to fulfil the updated capital requirements.

Impact on the Borrowers:

The updated regulations will impact unsecured personal loans, credit cards, and loans extended by Banks and NBFCs to other NBFCs for unsecured lending. However, these changes will not apply to secured products such as home loans, education loans, and car loans.

The RBI's decision to raise risk weights for personal loans is a timely and positive step following the central bank's warning about excessive lending in the unsecured consumer loans sector.

Although the overall financial impact of non-performing loans in this category may not be substantial, the significant number of individuals relying on easy credit for non-productive purposes, like purchasing consumer durable products and gadgets, is a cause for concern. This measure is expected to curb lenders who may have adopted lenient practices in loan assessment, a trend that has historically led to unfavourable consequences.

The increased risk weights for unsecured loans are expected to result in higher costs for lending from Banks and NBFCs to lending apps. Hence, this is likely to put pricing pressure on lending apps.

With the risk weightage raised from 100 per cent to 125 per cent, lending institutions, including fintech platforms, may now view these loans as riskier assets, necessitating increased capital requirements.

Practically, this could lead to higher interest rates and/or more stringent eligibility criteria for personal loan applicants. As lending institutions adapt to the new regulations, personal loan borrowers may face higher borrowing costs or find getting a personal loan more challenging due to the tightened lending rules.

The RBI's decision is poised to set off a series of events, slowing down retail loan consumption and subsequently impacting profitability. While this might increase funding costs for NBFCs in the short term, it is expected to contribute positively to the overall health of the industry from a broader perspective.

Therefore, how financial institutions adjust to regulatory changes and manage associated risks will shape the impact on personal loan borrowers. Remember, the interest rates for personal loans vary depending on factors like the selected bank and credit score. Therefore, before seeking a personal loan, you should compare the latest interest rates and processing fees provided by different reputable banks. It is advisable to use online Personal Loan Calculators available on various financial websites to calculate your EMI amount and interest outgo.

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KETKI JADHAV is a Content Writer at PersonalFN since August 2021. She is an MBA (Finance) and has over seven years of experience in Retail Banking. Ketki specialises in covering articles around banking, insurance, personal finance, and mutual funds and has been doing it for over three years now.

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