RBI's Lending Norm Changes and NBFC Funding Strategy

Key Points

• The Reserve Bank of India (RBI) has likely reduced risk weights on consumer microfinance loans by 25 percentage points to 100%, making it less costly for banks to lend in this sector.

• Risk weights on bank loans to Non-Banking Financial Companies (NBFCs) appear to have been restored to pre-November 2023 levels, encouraging banks to increase lending to NBFCs.

• NBFCs may shift their funding strategy toward bank loans, reducing reliance on commercial papers, which have risen to 40% of their funding mix.

• RBI’s concerns about perpetual credit lines suggest potential risks of loan evergreening, which could impact retail-focused NBFCs.

• These changes aim to balance financial inclusion with stability, but their full impact remains uncertain due to implementation timelines and market dynamics.

Overview

In March 2025, the RBI introduced changes to bank lending norms, as reported by Business Standard, which are expected to influence how NBFCs secure funding. These adjustments seem to make bank loans more attractive for NBFCs, potentially reducing their dependence on short-term instruments like commercial papers. The changes also address microfinance lending, a critical area for financial inclusion in India, while raising concerns about risky lending practices.

Why It Matters

NBFCs are vital to India’s economy, providing credit to underserved sectors like small businesses and low-income households. With only about 22% of Indian adults having access to formal credit in 2021, easing lending norms could expand financial access. However, the RBI’s caution about perpetual credit lines highlights the need to manage risks to maintain financial stability.

Potential Impacts

The reduced risk weights could lower borrowing costs for NBFCs and microfinance borrowers, fostering economic growth. However, the shift in funding strategies may take 6-9 months to materialize, and smaller NBFCs might face delays in accessing bank credit. The RBI’s focus on curbing risky practices could also limit some NBFCs’ operational flexibility.

Comprehensive Analysis of RBI’s Lending Norm Changes and Their Impact on NBFC Funding Strategies

Introduction

The Reserve Bank of India (RBI) has recently modified its lending regulations, a move that is poised to reshape the funding landscape for Non-Banking Financial Companies (NBFCs) in India. According to a Business Standard report published on March 11, 2025, these changes involve reducing risk weights on consumer microfinance loans and restoring earlier risk weight frameworks for bank loans to NBFCs. These adjustments are expected to encourage NBFCs to pivot toward bank loans, reducing their reliance on commercial papers, which have accounted for over 40% of their funding in recent quarters. Additionally, the RBI has expressed concerns about perpetual credit lines, signaling a focus on prudent risk management. This article provides a detailed, research-based analysis of these regulatory changes, their implications for NBFCs, and their broader impact on India’s financial ecosystem, enriched with data and Indian-specific context.

Background: The Role of NBFCs in India’s Financial System

Importance of NBFCs

NBFCs are pivotal in India’s financial landscape, serving as a bridge for credit access to segments often overlooked by traditional banks, such as micro, small, and medium enterprises, rural borrowers, and low-income households. In 2021, only 179 million Indians, or roughly 22% of adults, had access to formal credit, underscoring the critical role of NBFCs in financial inclusion. NBFCs contribute significantly to economic growth, with their assets under management (AUM) growing at a compound annual growth rate (CAGR) of approximately 14% from 2014 to 2024, though growth is projected to slow to 15-17% in FY25 and FY26 due to regulatory and liquidity challenges.

Funding Sources

NBFCs fund their operations through a mix of sources, including:

• Bank Loans: Long-term, stable funding, often secured at competitive rates.

• Commercial Papers (CPs): Short-term debt instruments with maturities typically under one year.

• Bonds and Debentures: Medium- to long-term debt securities.

• Securitization: Selling loan portfolios to raise funds.

• Public Deposits: Limited to certain NBFCs, subject to strict RBI regulations.

Recent data from CRISIL Intelligence indicates that NBFCs’ reliance on CPs has increased significantly, with CPs constituting 40% or more of their funding mix over the past seven quarters, up from less than 30% previously. This shift reflects the need for quick, flexible funding but exposes NBFCs to liquidity risks, especially during market tightening. The RBI’s recent regulatory changes aim to address these dynamics by making bank loans more accessible, potentially stabilizing NBFC funding structures.

RBI’s Regulatory Changes: A Detailed Examination

In early 2025, the RBI introduced two significant adjustments to its lending norms, as detailed below, based on reports from Business Standard and other sources.

1. Reduction in Risk Weight on Consumer Microfinance Loans

The RBI has reduced the risk weight on consumer microfinance loans by 25 percentage points, from 125% to 100%, effective immediately for both outstanding and new loans. This change reverses a November 2023 decision that increased risk weights on consumer credit, including personal loans and NBFC exposures, to 125% to curb rapid growth in unsecured lending.

What Are Risk Weights?Risk weights are regulatory tools used to determine the minimum capital banks must hold against assets based on their perceived risk. A 100% risk weight means a bank must hold capital equivalent to 8% of the loan amount (assuming a capital adequacy ratio of 8%), while a 125% risk weight requires 10% capital. Lowering the risk weight to 100% reduces the capital banks need to hold, making microfinance lending less costly and more attractive.

Context of the ChangeIn November 2023, the RBI raised risk weights on consumer credit to address concerns about overheating in unsecured lending, which posed risks to financial stability. Microfinance loans, often categorized as consumer credit, were included in this hike, increasing costs for banks and NBFCs. The February 2025 adjustment exempts microfinance loans from the higher 125% risk weight, aligning them with other priority sector loans like housing and education, which typically carry a 100% risk weight.

Impact on MicrofinanceThis reduction is expected to boost credit flow to microfinance borrowers, who are typically low-income individuals and micro-entrepreneurs. In India, the microfinance sector serves over 60 million clients, with a loan portfolio of ₹4.2 lakh crore as of March 2023. By lowering capital requirements, banks and NBFCs can expand lending to this segment, supporting financial inclusion and rural economic growth.

2. Restoration of Risk Weights on Bank Loans to NBFCs

The RBI has restored risk weights on bank loans to NBFCs to their pre-November 2023 levels, effective April 1, 2025. In November 2023, the RBI increased risk weights on bank exposures to NBFCs by 25 percentage points above the risk weight associated with the NBFC’s external rating, citing concerns about NBFCs’ growing dependence on bank funding. For example, a loan to an AAA-rated NBFC, previously at a 20% risk weight, was raised to 45%. The restoration of earlier risk weights reduces the capital banks need to hold for these loans, making NBFC funding more attractive.

Context of the ChangeThe 2023 hike led to a slowdown in bank credit to NBFCs in FY25, with tighter liquidity conditions exacerbating funding challenges. NBFC credit growth dropped from 23% in FY24 to a projected 15-17% in FY25, partly due to reduced bank lending. The RBI’s decision to roll back this increase reflects a strategic response to liquidity deficits and the need to support credit flow to underserved segments.

Impact on NBFC FundingLower risk weights make bank loans a more cost-effective funding source for NBFCs. Banks are likely to prioritize lending to well-rated NBFCs (e.g., AAA or AA-rated) initially, with smaller or lower-rated NBFCs potentially facing delays. Industry experts estimate a 6-9 month transition period for banks to fully adjust their lending practices.

3. RBI’s Concerns About Perpetual Credit Lines

The RBI has raised concerns about perpetual credit lines, which may facilitate loan evergreening—extending new loans to repay existing ones to mask non-performing assets (NPAs). The central bank has advised lenders to slow the issuance of such credit lines to ensure prudent risk management. This caution is particularly relevant for retail-focused NBFCs, which often rely on revolving credit facilities to manage cash flows and lending operations.

What Is Loan Evergreening?Loan evergreening involves renewing or extending loans to borrowers who are unable to repay, thereby delaying the recognition of bad loans. This practice can inflate NPAs and undermine financial stability. The RBI’s focus on this issue suggests heightened scrutiny of NBFCs’ lending practices, especially in consumer and retail segments.

Impact on NBFCs: A Shift in Funding Strategy

The RBI’s regulatory changes are expected to significantly influence NBFCs’ funding strategies, as outlined below.

Increased Attractiveness of Bank Loans

With lower risk weights on bank loans to NBFCs and consumer microfinance loans, banks can lend more without significantly increasing their capital requirements. This makes bank funding more attractive than short-term instruments like CPs, which carry higher liquidity risks. Bhushan Kedar from CRISIL Intelligence notes that NBFCs are likely to prioritize bank loans, especially if interest rates are lowered, leading to a more balanced funding mix.

Shift in Funding Mix

NBFCs’ reliance on CPs, which rose to 40% or more of their funding mix, reflects a preference for short-term, flexible funding. However, CPs expose NBFCs to refinancing risks, particularly during liquidity crunches. The RBI’s changes encourage a shift toward bank loans, which offer longer tenures and greater stability. For example, NBFCs like Muthoot Finance, which specialise in microfinance and gold loans, are expected to benefit from increased bank funding, as noted by George Alexander Muthoot, managing director of Muthoot Finance.

Timeline and Prioritization

Banks are expected to take 6-9 months to return to pre-2023 lending levels, prioritizing well-rated NBFCs initially. Smaller or lower-rated NBFCs may face delays in accessing credit, potentially exacerbating funding challenges for these firms. This staggered approach reflects banks’ cautious response to regulatory changes and liquidity conditions.

Impact on Microfinance Lending

The reduced risk weight on consumer microfinance loans is likely to lower borrowing costs for NBFCs and their clients. Microfinance institutions (MFIs), a subset of NBFCs, serve over 60 million borrowers, primarily women in rural and semi-urban areas. The lower risk weight could enable MFIs to expand their loan portfolios, supporting initiatives like women’s entrepreneurship and rural development.

Challenges and Risks

Despite the potential benefits, the RBI’s changes introduce several challenges:

1. Privacy and Regulatory Compliance

While not directly related to risk weights, NBFCs must navigate India’s stringent data protection laws, such as the Personal Data Protection Bill (PDPB) 2023, when leveraging digital lending platforms. The use of alternative data for credit scoring, often employed by NBFCs, requires explicit borrower consent, adding operational complexity.

2. Loan Evergreening and Financial Stability

The RBI’s concerns about perpetual credit lines highlight risks of loan evergreening, particularly among retail-focused NBFCs. Increased scrutiny could limit these NBFCs’ operational flexibility, potentially raising compliance costs. Non-compliance risks penalties, as seen in the RBI’s 2022 crackdown on non-compliant digital lenders.

3. Liquidity and Funding Access

Smaller NBFCs, especially those with lower credit ratings, may struggle to access bank loans during the initial 6-9 month transition period. This could exacerbate liquidity challenges, particularly in a tight market environment. The projected slowdown in NBFC AUM growth to 15-17% in FY25 reflects these pressures (CRISIL Ratings).

4. Digital Divide

While NBFCs leverage digital platforms for lending, India’s digital divide—24% rural internet penetration versus 66% urban—limits their reach. Rural borrowers, a key microfinance demographic, may face barriers to accessing digital lending services, potentially undermining the impact of reduced risk weights.

Data and Expert Insights

NBFC Sector Overview

• AUM Growth: NBFC AUM grew at 23% in FY24 but is projected to slow to 15-17% in FY25 and FY26 due to regulatory tightening and liquidity challenges.

• Funding Mix: CPs accounted for 40% or more of NBFC funding over the past seven quarters, up from less than 30%.

• Microfinance Portfolio: ₹4.2 lakh crore across 60 million clients as of March 2023.

• Credit Gap: MSMEs face a ₹37 lakh crore credit gap, with NBFCs filling a significant portion.

Future Outlook

The RBI’s regulatory changes are part of a broader effort to balance financial inclusion with stability. Several trends and initiatives could shape the future of NBFC funding:

• Account Aggregator Framework: With over 100 million linked accounts in 2024, the AA framework enables secure data sharing, potentially enhancing NBFCs’ credit assessment capabilities.

• Unified Lending Interface (ULI): Introduced by the RBI Innovation Hub, ULI aims to streamline digital lending, benefiting NBFCs by reducing customer acquisition costs.

• Diversification of Funding Sources: The RBI encourages NBFCs to diversify beyond bank loans and CPs, such as through bonds or securitisation, to mitigate liquidity risks.

• Digital Lending Growth: NBFCs are adopting technologies like AI and ML for credit scoring, but must comply with PDPB regulations to protect borrower data.

• Rural Focus: Reduced risk weights on microfinance loans could drive NBFC lending in rural areas, where 488 million internet users reside, though connectivity gaps remain.

Conclusion

The RBI’s adjustments to lending norms in early 2025 mark a strategic pivot to support NBFCs and microfinance lending while addressing risks like loan evergreening. By reducing risk weights on consumer microfinance loans to 100% and restoring pre-2023 risk weights on bank loans to NBFCs, the RBI is facilitating increased credit flow to underserved segments, crucial for India’s financial inclusion goals. NBFCs are expected to shift their funding strategies toward bank loans, reducing reliance on volatile commercial papers, which have risen to 40% of their funding mix. However, challenges such as liquidity constraints, regulatory compliance, and the digital divide must be navigated to maximize the benefits of these changes. As NBFCs adapt, supported by digital innovations and regulatory frameworks, they are poised to strengthen their role in driving India’s economic growth.

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