Mumbai: Risks in India's banking sector may rise as a result of the central bank's recent steps encouraging banks to lend more to non-bank financial institutions (NBFCs) and retail borrowers said Fitch Ratings. It said that if banks direct more funds to the sector, mostly the strongest NBFCs are likely to be benefited.
RBI announced three main steps in August to encourage banks to lend more: an increase in the single-exposure limit to 20 per cent of Tier 1 capital from 15 per cent; priority lending status for credit to NBFCs for on-lending to finance agriculture, small businesses and home-buyers; and a reduction in the risk weight for consumer loans to 100 per cent from 125 per cent. This follows several other initiatives in recent months to boost lending, including harmonising risk weights on NBFC exposure, allowing banks to raise additional liquidity by selling excess government securities, and a partial credit guarantee from the government on banks' asset purchases from NBFCs.
"These initiatives are designed to help keep credit flowing to the real economy amid signs of a slowdown. Averting a significant slowdown would help borrowers and therefore the stability of the financial system, but the measures could push up banking-sector risk if they lead banks to accept higher credit risk than they previously had appetite for," said the rating agency.
Fitch observed that India's constant nudging of banks to lend more to the shadow banking sector is in contrast to the global trend of authorities trying to break the linkages between banks and NBFCs.
"India's overarching approach across the financial system is aimed at achieving a more inclusive financial system in which bank savings can support lending to parts of the economy that are beyond the banks' distribution network or risk appetite. However, it increases the potential of risks in the NBFC sector spilling over to banks, exacerbated by the limited capacity of India's capital markets to provide extra funding to NBFCs," warned the agency."