Assigning higher risk weights on large loans to unrated firms improved repayments, says RBI study

Mumbai: A policy shift to insist on higher risk weights on large loans which are unrated has had the desired impact with a shift in borrower behaviour, a Reserve Bank of India (RBI) study has found. The RBI had introduced the move in 2016 with a view to nudge banks to have rated exposures.

"In aggregate terms, the change in policy resulted in a 50 percent decline in the treated borrowers' likelihood of switching from rated to unrated categories over quarters," an RBI study by Pallavi Chavan and SK Ritadhi said on Thursday. This impact of the change in policy was significantly higher among borrowers of public sector banks than private sector banks, it added.

The RBI had introduced the move to plug the regulatory arbitrage in terms of risk weights between rated and unrated exposures above a specific threshold for the size of bank exposure to the borrower, it said.

 Assigning higher risk weights on large loans to unrated firms improved repayments, says RBI study

Representational image. Reuters.

"The policy had the desired impact in discouraging a switch among the treated group of borrowers from the rated to the unrated category," it said.

It said unrated borrowers account for about 60 percent of the total number and 40 percent of the total exposure of "large" borrowers with funded and non-funded exposure in excess of Rs 5 crore in the Central Repository of Information on Large Credits.

Given the extensive use of credit ratings in the assessment of capital adequacy in banks, the presence of unrated exposures can create information barriers for banks as well as the supervisor, it said.

The study also said while the increase in risk weights has been an "apt one-time regulatory measure", there is a need for continuous monitoring of unrated large exposures by banks using information gathered from market sources and the history of bank-borrower relationship.

It also said banks cannot lose sight of the fact that external ratings cannot be a substitute for their internal due diligence on a borrower's credit quality.

Updated Date: Jul 05, 2019 07:35:08 IST