Banks Remain Cautious in Lending to NBFCs Despite Risk Weight Restoration

Despite the restoration of risk weights for loans to Non-Banking Financial Companies (NBFCs) by the Reserve Bank of India (RBI), banks remain cautious about lending to NBFCs, particularly those focused on unsecured personal loans and the microfinance segment. While larger NBFCs with higher credit ratings may continue to attract financing, smaller and mid-sized players, which have lower credit ratings and significant exposure to unsecured loan books, are encountering major difficulties in raising funds from banks.

In February 2025, the RBI slashed the risk weights for loans to NBFCs by 25 percentage points, depending on the credit ratings of these entities. This came after the regulator had increased the risk weights by 25 percentage points in November 2023, specifically for cases where the external ratings of NBFCs were below 100 percent. The concept of "risk weight" refers to the capital that banks must set aside as a provision to cover the risk of loan defaults. The restoration of risk weights was seen as a positive move for NBFCs, but banks remain hesitant due to the risky nature of unsecured and personal loans.

Shachindra Nath, the founder and managing director of UGRO Capital Ltd., an NBFC that specializes in MSME and small business financing, emphasized that many banks are still reluctant to lend to NBFCs operating in areas like microfinance, consumer loans, or personal loans. However, UGRO Capital has been able to continue receiving funding from banks and did not face any significant issues, even when risk weights were increased in the past. This highlights that larger and more stable NBFCs, even if engaged in riskier segments, can continue to access funding, but smaller and less-rated players still struggle.

Prakash Agarwal, Partner at Gefion Capital Advisors, echoed Nath’s sentiments, stating that the reduction in risk weights is unlikely to lead to a significant increase in loan disbursements to NBFCs. Regardless of the changes in risk weights, banks remain wary of lending to mid-sized and small NBFCs. Many of these smaller players have a large portion of their loan portfolios in unsecured and semi-secured segments, which are inherently riskier. As a result, these NBFCs have scaled back their lending activities, contributing to a decrease in demand for loans.

Additionally, banks are also cautious about extending credit to NBFCs with lower ratings, as they are seen as higher-risk borrowers. The cautious approach by banks is due to the fact that unsecured loans tend to have higher default rates, especially when extended to borrowers with lower creditworthiness. As a result, even though the RBI’s reduction in risk weights provides some relief, it has not been enough to significantly change the lending behavior of banks toward NBFCs.

It is also important to note that while banks’ lending to the NBFC sector grew by 5.7% as of March 21, 2025, this is a significant decline from the 15.3% growth seen during the same period in the previous year. This decline reflects the ongoing wariness of banks toward the NBFC sector, particularly those smaller, unsecured lending-focused entities that are viewed as riskier. This slower growth in bank lending indicates that the reduced risk weights, though helpful, have not fully alleviated the concerns that banks have about extending credit to NBFCs, especially those with lower credit ratings or those involved in unsecured lending.

Overall, while the restoration of risk weights by the RBI was a positive step, it has not been sufficient to instill confidence in banks to significantly increase lending to NBFCs, particularly those involved in riskier lending segments such as microfinance and unsecured personal loans. The cautious stance from banks continues to be a challenge for smaller NBFCs, which are struggling to access funding and continue their lending operations.