IndusInd Bank, Bandhan Bank, and NBFC Stocks Surge Up to 8% as RBI Reduces Risk Weights

The Reserve Bank of India (RBI) has introduced several measures that are expected to benefit certain banks and non-banking financial companies (NBFCs). Firstly, the central bank has reduced risk weights on microfinance institution (MFI) business loans provided by banks from 125% to 75% and on MFI consumption loans to 100%. Secondly, it has reinstated risk weights on loans to NBFCs to levels that existed before November 2023, reversing the 25% increase imposed last year. Additionally, the RBI has granted Muthoot Finance approval to open 115 new branches. These regulatory changes are expected to provide much-needed relief to banks and NBFCs, potentially boosting credit flow and profitability.

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Impact on MFI-Heavy Banks

The relaxation in MFI risk weights is likely to benefit banks with significant exposure to the MFI sector, excluding small finance banks (SFBs). According to Nuvama, Bandhan Bank and RBL Bank stand to gain the most from these changes. This move could also encourage greater lending activity in the microfinance sector, which plays a crucial role in financial inclusion.

While the rollback in MFI risk weights is advantageous for banks heavily invested in this segment, it does not significantly impact SFBs, as most of them had not raised MFI loan risk weights to 125%. AU Small Finance Bank was an exception, applying the higher risk weight only to 20% of its MFI loans related to consumption, while other SFBs had not implemented any such increase.

Banks that had raised risk weights on MFI loans include Bandhan Bank, RBL Bank, IDFC First Bank, and IndusInd Bank. These institutions are expected to see an improvement in their capital adequacy ratio (CAR), with Bandhan Bank and RBL Bank benefiting the most, according to Nuvama. The improved CAR levels could help these banks expand their lending operations while maintaining regulatory compliance.

Impact on NBFCs

Nuvama noted that the easing of risk weights for NBFCs would lower their cost of funds, with Cholamandalam Investment and Finance Ltd being one of the primary beneficiaries. The relaxed norms also improve the likelihood of the RBI approving Sumant Kathpalia’s (CEO of IndusInd Bank) reappointment for a three-year term. Analysts suggest that these measures could enhance liquidity and capital adequacy for several financial institutions, further stabilizing the sector.

Regarding exposure to NBFCs, IDFC First Bank, ICICI Bank, and Bank of Baroda (BoB) have significant lending in this segment. Lower risk weights on NBFC loans will reduce the cost of funds for NBFCs, especially those that rely heavily on bank borrowings. However, given the increasing risks in the sector, Nuvama does not anticipate banks aggressively expanding their NBFC lending despite this relaxation.

It is worth noting that priority sector lending and loans to housing finance companies were already exempt from higher risk weights. Many NBFC MFIs had shifted to pass-through certificates (PTC) or direct assignment (DA) structures to secure funding. Due to ongoing challenges in the sector, banks are expected to favor these indirect funding routes over direct lending. This could influence future lending strategies and risk management practices.

Challenges in the MSME Sector

Nuvama also highlighted rising stress in small-ticket MSME lending, suggesting that banks may maintain a cautious approach. As a result, the relaxation in risk weights is expected to benefit larger NBFCs more than smaller ones. Increased regulatory flexibility could allow well-capitalized NBFCs to expand operations while ensuring financial stability.

Despite the relaxation, risks remain in the MSME lending space, where small businesses continue to struggle with cash flow issues. Banks and NBFCs may still be hesitant to take on additional exposure in this segment due to concerns about asset quality and potential defaults.

Expected Impact on Capital Adequacy and Lending

In terms of impact, Nuvama estimates that Bandhan Bank’s CAR could improve by 280–300 basis points in an optimal scenario, while RBL Bank may see an increase of 40 basis points, IDFC First Bank by 25 basis points, and AU SFB by 15 basis points. While the MFI-related relaxation positively affects banks’ CAR, the NBFC-related adjustment primarily benefits NBFCs rather than banks.

For banks, the reduced risk weights on NBFC loans may lead to lower margins without a significant impact on risk-adjusted return on capital (RAROC). These developments could shape future regulatory policies and lending dynamics in the financial sector. Overall, while the RBI’s measures provide relief, financial institutions are expected to remain cautious amid ongoing economic uncertainties.