The Reserve Bank of India (RBI) has asked banks and non-banking financial firms (NBFCs) to enhance consumer and bank credit risk weights by an additional 25 percentage points. This means that banks will require more capital, and as a result, consumer credit interest rates may rise.

Ashima Goyal, a member of the Monetary Policy Committee (MPC), hinted to this in the October policy when she remarked that taking preventive measures, such as altering loan-to-value (LTV) ratios or adjusting risk weights, would be a better option than raising policy rates. "This also resonates with the monetary policy stance, wherein incremental withdrawal of easy money availability is the bottom line, as it poses a risk of unnatural demand," Akhil Mittal, Senior Fund Manager, Tata Asset Management, concurs.

"Current credit growth does pose a risk of speculative demand, and the RBI is actively working to mitigate that risk." "Because monetary policy alone cannot respond to all economic developments, central banks look at tools and options other than monetary policy to ensure stability and meet objectives," says Mittal of Tata Asset Management.

"In fact, the RBI's action reflects a strategic shift." While raising policy rates affects all borrowers, tightening prudential requirements, particularly in high-risk sectors such as unsecured lending for discretionary purchases such as gadgets, illustrates a more targeted approach', says Jaya Vaidhyanathan, CEO of BCT Digital.

According to Rishabh Goel, co-founder and CEO of Credgenics, the RBI's actions indicate a shift away from depending primarily on traditional monetary policy tools such as interest rate increases. Instead, the RBI is examining additional regulatory alternatives in order to mitigate the possible risks connected with unsecured lending.

"This move reflects a nuanced approach to managing inflation and demand," adds Goel, "highlighting the RBI's commitment to employing a diverse set of tools to navigate the dynamic economic challenges proactively and effectively."

According to market sources, the RBI is taking the bull by the horns by boosting risk weights on unsecured loans, particularly small-ticket loans. According to them, this demonstrates the central bank's commitment to promote safer lending practises and responsible consumer behaviour through regulatory measures.

"The recent increase in risk weight assessment is expected to result in a marginal increase in unsecured loan pricing, which will have a short-term impact on their unprecedented growth." Despite these modifications, the overall prognosis for retail financing remains positive, as several factors are supporting the consumption and GDP upswing," Goel notes.

Following the Ukraine crisis last year, the RBI altered its focus in April 2022, hiking the repo rate by 250 basis points between May 2022 and February 2023 to combat excessive inflation. The RBI has been working hard to reduce inflation to its tolerable goal range of 4 percent. In fact, raising interest rates is only one of the options at their disposal.

"The tightening of unsecured lending norms represents a strategic opportunity for lenders to rethink their approaches to loan disbursement and recovery." These short-term modifications are expected to have an immediate impact on operations, but they are strategically positioned to have a positive and long-term influence on the lending industry's trajectory. "As the industry adapts to these changes, the RBI's move opens up avenues for innovation and emphasises the importance of responsible lending practices," Goel said.