What is Risk weight?

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What is Risk weight? Blog Image

Overview:

Recently, the Reserve Bank of India (RBI) has increased the cost of funds for banks and non-bank financial companies (NBFCs), by increasing the risk weight of such loans.

Why in the news?

  • The Reserve Bank of India has raised risk weight on consumer credit by banks and NBFCs to 125%, compared to 100% earlier.

About Risk weight

  • Every rupee lent by the bank is a cost or has an implication on its capital position. 
  • Risk-Weighted Assets: These are used to determine the minimum amount of capital a bank must hold in relation to the risk profile of its lending activities and other assets.
  • The Reserve Bank of India decided in April 1992 to introduce a risk asset ratio system for banks (including foreign banks) in India as a capital adequacy measure in line with the Capital Adequacy Norms prescribed by Basel Committee.
  • Impacts
    • Lower the risk weight, lower the rate of interest. Therefore, risk weights impact borrowers indirectly and is felt through the pricing of loans.
    • The increase in risk weights by the RBI will elevate funding costs for NBFCs and impact capital requirements.

Q1) What Is the Capital Adequacy Ratio?

The capital adequacy ratio (CAR) is an indicator of how well a bank can meet its obligations. Also known as the capital-to-risk weighted assets ratio (CRAR), the ratio compares capital to risk-weighted assets and is watched by regulators to determine a bank's risk of failure. 

Source: What does the RBI’s increase in risk weights mean to the borrower?