The Reserve Bank of India’s (RBI) regulatory changes mandating revised risk weights for rated and unrated exposures helped discourage large borrowers from making a switch from rated to unrated exposures, according to the central bank. An RBI study, released last week, found that in aggregate terms, the change in policy (2016 regulatory changes) resulted in a 50 per cent decline in the treated borrowers’ likelihood of switching from rated to unrated categories over quarters. Interestingly, the impact was significantly higher among Public Sector Bank borrowers than private banks.
An accurate assessment of both the creditworthiness of borrowers and the capital levels in banks is unlikely if there are more unrated exposures. Given the prevalence of large unrated exposures in the banking system was high, RBI modified the prudential regulatory guidelines in 2016 to plug the regulatory arbitrage in terms of risk weights between rated and unrated exposures above a specific threshold.
According to estimates, unrated borrowers account for about 60 per cent of the total number and 40 per cent of the total exposure of large borrowers (with funded and non-funded exposure in excess of Rs 5 crores) in RBI’s Central Repository of Information on Large Credits (CRILC). Their share is distinctly higher in private banks as against PSBs. As unrated borrowers comprise a lower share in terms of the total exposure compared to total borrowers, it indicates that borrowers with relatively small exposures are more likely to be unrated.
Between June 2014 (the first quarter for which CRILC data are available) and December 2015, shares of the number of NPA borrowers within the total number of unrated borrowers and the amount of NPAs in the total amount of unrated exposures showed a comparable magnitude and trend. However, after December 2015, it diverged with the share of NPAs in unrated exposures outpacing the share of non-performing borrowers.
While the share of non-performing borrowers stagnated in the range of 13-14 per cent, the share of NPA amount in unrated exposures increased sharply to about 24 per cent by December 2018. In 2016, regulatory guidelines were modified to raise risk weight for claims on corporates, Asset Finance Companies and Non-Banking Financial Companies-Infrastructure Finance Companies - having aggregate exposure from the banking system of more than Rs 100 crore - to 150 per cent if these exposures were rated earlier and subsequently became unrated. And, the risk weight for unrated claims having aggregate exposure of above Rs 200 crores was increased to 150 per cent.
While the increase in risk weight has been a one-time regulatory measure, the study noted that there was a need for continuous monitoring of unrated large exposures by banks using market information and the history of the bank-borrower relationship. “Also, banks cannot lose sight of the fact that external ratings cannot be a substitute for internal due diligence on a borrower’s credit quality,” it noted.
Regulatory impact in aggregate terms, the change in policy resulted in a 50 per cent decline in the treated borrowers’ likelihood of switching from rated to unrated categories. Interestingly, the impact was significantly higher among Public Sector Bank borrowers than private banks