Banks have asked the regulator to consider lowering the ‘risk weight’ on loans to unrated small and medium enterprises. An overwhelming number of small businesses do not have any ratings that bigger businesses and corporates obtain from credit rating agencies to get a better deal from lenders.
“About a month ago, the industry drew RBI’s attention to the fact that the present risk weight assigned by the regulator to such unrated SME loans is higher than what is internationally accepted. So, there is a room to lower the weight. Once the weight is reduced, most banks would be willing to lower the interest rate on loans a little to the SME borrowers,” a senior banker told ET.
A reduction in risk weight can bring down interest rate by at least 30-40 basis points.
Risk weights, which are linked to a borrower’s credit rating, reflect the risk of loss from non-payment by the borrower. Lower the credit rating on a borrower, higher is the risk weight and higher the interest the lender charges on such loans.
According to the Basel III norms – the globally agreed set of measures developed by the Basel Committee which is headquartered at the Bank for International Settlements (BIS) in Basel – the risk weight attached to loans to unrated corporate SMEs is 85% as against at least 100% stipulated by RBI for any unrated company.
Since a higher risk weight pushes up the level of capital banks are required to have, a lower weight saves capital and gives banks the scope to cut interest rate on loan. (The minimum capital adequacy of 9% that banks have to maintain is the ratio between all risk-weighted assets and total capital).”Loans to SMEs are typically all secured loans. So, the suggestion to the RBI (for lowering risk weight to unrated SMEs) is unrelated to the recent decision to increase weights on unsecured loans. Now, with businesses availing input credit under GST, many SMEs have come under the formal fold. So, banks are comparatively more comfortable lending to them than before. The industry doesn’t think that lowering weight on unrated SMEs would make banks vulnerable in any way,” said another banker.
Many banks, including some of the large state-owned lenders, do not insist on credit ratings on loans up to ₹50 crore – primarily because it helps banks as well as the borrowers not to have one. While ratings of triple-A, double-A and A would mean lower risk weights of 50% or below, a double-B rating carries a risk weight of more than 100%. Thus, the weight (of 100%) on a loan to an unrated borrower is lower than that of the weight and capital required for a double-B rated borrower. Since many SMEs would be double-B rated, an unrated status may be more advantageous.
Even though banks’ dealing with SMEs have somewhat changed over the years, many small entrepreneurs resort to private credit as most banks and large non-banking finance companies have limited exposure to them. In the void created over the past few years with NBFCs shrinking their books, alternative investment funds (AIFs) are slowly emerging as providers of debt capital to some of the smaller and unrated businesses.
According to a recent report by Praxis Global Alliance and Indian Venture & Alternate Capital Association, Indian private credit investments have grown rapidly – deploying $5.1 billion in H12023 with average deal size of $80 million, up from $2.4 billion in 2018 when the average deal size was $16 million.