Is the RBI lifting weights now to boost its image?

Well, you are pretty close. The RBI did do some heavy lifting last week, when it came out with a slew of measures to lower borrowing costs and boost demand in the economy. Altering the risk-weights that apply to home loans was one such measure.

‘Risk’, ‘weights’…what?

Oh yes, let’s first understand what risk-weights are? While much of a bank’s activities are funded by deposits, these have to be repaid at a future date. Hence, a financially sound bank needs a large buffer of capital to remain viable so it can absorb sudden losses. This is the reason why regulatory efforts to strengthen banks usually start with the Capital Adequacy Ratio (CAR).

Presently, Indian banks need to have a total CAR of 10.875 per cent of their risk-weighted assets. Herein comes the concept of risk-weights! RBI regulations ensure that the amount of own capital that a bank holds is pegged to the profile of its borrowers; riskier the borrowers, higher the capital needed. The RBI assigns different ‘risk weights’ to different types of loans based on the possible defaults for each category.

So what risk-weights apply to home loans?

Prior to the RBI’s announcement last week, home loans between ₹30 lakh and ₹75 lakh carried 35 per cent risk weight, while loans above ₹75 lakh carried higher 50 per cent risk weight. For low-ticket loans up to ₹30 lakh, a risk-weight of 35 per cent and 50 per cent was applicable depending on the loan-to-value (LTV) ratio. This LTV based risk-weight has now been extended to all home loans.

Woah, hold on…now what is LTV?

Don’t get flummoxed by the jargon. What happens when you approach a bank for a loan for purchase of a house worth, say, ₹1 crore? Does the bank give you the entire ₹1 crore as loan? No, it asks you to put some money from your pocket, say, ₹25 lakh, to fund the purchase as a margin. This implies that the bank has given you a loan based on 75 per cent LTV. Hence, the LTV ratio is the ratio of the loan amount vis-à-vis the value of the property.

Ok, got it. So how has the RBI linked this to risk-weights?

For new loans (up to March 2022), irrespective of the ticket size, a risk weight of 35 per cent will apply where the LTV is equal to or less than 80 per cent, and 50 per cent where the LTV is 80-90 per cent. So essentially if the borrower puts in more money from her pocket (20 per cent or more of the value of the property) then the bank will apply lower risk weight of 35 per cent.

How does that help a bank?

Remember, banks have to carry capital commensurate with the risk-weighted assets. If risk weights come down for certain loans, then it will have to set aside lower capital.

I am still confused, how does that help me as a borrower?

With banks having to carry lower capital on big-ticket home loans above ₹75 lakh (if the LTV is 80 per cent or lower), their costs come down. You know, raising capital entails costs. Hence, banks can pass on this benefit to borrowers in the form of lower borrowing rates. So, your big-ticket home loan could get cheaper!

So time to ride the bandwagon?

Only if you have found a good deal. Remember aside from lending rates there are other key factors such as location, real estate market, property price and above all stability of income, that impact your decision to buy a new property. Besides, the RBI’s move may nudge a few banks to lower lending rates by a few basis points. So don’t jump the gun for just this reason.

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