The Reserve Bank of Indias decision to reduce risk weight on consumer loans is credit negative as it will encourage banks to increase their exposure to this loan segment at a time when credit risks are already increasing amid a slowdown in the economy, Moodys Investors Service said on Wednesday.

To reduce the cost of loans and boost demand, the banking regulator last week reduced risk weight on consumer loans such as personal loans to 100% from 125%. However, credit card receivables were excluded from the relaxation.

Personal loans have been reporting strong growth in India over the last few years. The segment's compounded annual growth rate (CAGR) of around 22% over fiscal 2013-2019 far exceeded that of 11% in overall banking system loans over this period. Personal loan growth has been particularly strong among large private sector banks, Moodys said.

The ratings agency said the strong growth of personal loans in recent years was supported by the yields offered by these unsecured loans, which were among the highest within retail lending. A benign credit environment, characterized by relatively low credit costs across all key retail loan segments, was a key driver of this growth as it prompted banks to focus on personal loans for their higher yields," it said.

The banking regulators latest decision will lower banks capital requirements and thus the loss absorbing buffer on these loans. It will also encourage banks to further increase their exposure to this cyclical segment at a time when the macroeconomy is slowing, Moodys said.

Indian economy grew at its slowest pace in six years at 5% during the quarter ended June, amid sluggish demand, slowdown in private investment, stress in the non-banking financial companies (NBFCs), downturn in the automobile, and job losses.

This raises the risk that asset risk on unseasoned personal loans will rise as a result of potential deterioration in household financial conditions," Moodys said.

Within rated banks, HDFC Bank Limited (Baa2 stable, baa2) has a higher exposure to the personal loans segment and are thus more vulnerable to the potential rise in asset risk as a result of this development," it said.

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Moodys says RBIs decision to cut risk weight on consumer loans credit negative - Livemint