RBI's Recent Policies: Impact of Risk Weight Increases and Rupee Depreciation Management on Indian Equity Markets
The Reserve Bank of India has implemented significant policy shifts in recent months that have substantially impacted financial markets. The central bank's decision to increase risk weights for unsecured lending and its evolving approach to rupee management under new Governor Sanjay Malhotra have created ripple effects throughout India's equity markets. These policy changes, occurring against the backdrop of global economic pressures, have contributed to market volatility and sector-specific challenges. The combination of tighter lending norms and a more hands-off approach to currency management has altered the investment landscape, with particularly pronounced effects on banking, financial services, and import-dependent sectors.
Evolution of RBI's Risk Weight Policies
The Reserve Bank of India implemented a significant policy change in November 2023 by increasing the risk weighting for unsecured loans from 100 percent to 125 percent. This decision came after the central bank observed concerning growth trends in unsecured lending, with bank credit growing at approximately 20 percent, credit card loans surging by about 30 percent, and personal loans increasing by roughly 25 percent. The increased risk weights applied to consumer credit exposure of commercial banks, specifically targeting personal loans while excluding housing loans, education loans, vehicle loans, and loans secured by gold and gold jewelry. This policy change was implemented with immediate effect and applied to both new and outstanding loans, representing a proactive measure by the RBI to curtail what it perceived as potentially excessive growth in high-risk lending sectors.
The scope of this policy change was substantial, affecting approximately 30 percent of banks' retail portfolios, which totaled around Rs 48.26 trillion at the end of September 2023. In addition to personal loans and credit card exposure, the RBI also increased risk weighting for bank loans to higher-rated Non-Banking Financial Companies (NBFCs) by 25 percentage points, creating a cascading effect throughout the financial system. This move represented a clear signal from the central bank that it was concerned about the potential systemic risks posed by rapidly expanding unsecured credit and wanted financial institutions to exercise greater caution in this segment.
Impact on Banks and Financial Institutions
The increase in risk weights had a direct impact on banks' regulatory capital requirements, particularly affecting their Common Equity Tier 1 (CET-1) capital. Financial analysts estimated that banks would face a hit of approximately 50-60 basis points on their CET-1 ratios as a result of this policy change. Among the banking institutions, smaller private sector banks with higher exposure to unsecured lending, such as RBL Bank and IDFC First Bank, were projected to experience the most significant impact on their capital adequacy metrics. The policy effectively required banks to allocate additional capital against their unsecured loan portfolios, potentially constraining their ability to expand these business segments without raising fresh capital.
For NBFCs, the impact was twofold. First, as banks faced higher capital requirements for lending to NBFCs, the cost of borrowing for these institutions increased. Second, NBFCs themselves needed to allocate higher Capital to Risk-Weighted Assets Ratio (CRAR) for each unsecured loan in their portfolio, putting pressure on their margins and overall profitability. Among major NBFCs, Bajaj Finance was expected to experience a moderate margin impact due to its diversified portfolio, while credit card companies like SBI Cards, with 100 percent unsecured loan exposure, were anticipated to face more substantial challenges to their business models and profitability.
Implications for Lending and Credit Growth
The immediate consequence of higher risk weights was an increase in the cost of capital allocation for banks and NBFCs engaged in unsecured lending. This higher cost inevitably translated into pressure to increase interest rates on such products to maintain return on equity targets. As a result, loans became more expensive for borrowers, particularly in the personal loan and credit card segments, potentially dampening demand for these credit products. Alternatively, financial institutions could choose to reduce their exposure to such high-risk segments and redirect their lending focus toward areas that consumed less capital, such as secured loans.
This shift in lending patterns was precisely what the RBI intended to achieve with its policy intervention. By making it more capital-intensive to extend unsecured credit, the central bank effectively created a regulatory incentive for financial institutions to moderate their growth in these segments and adopt more cautious lending practices. The historical data suggests that such risk weight adjustments by the RBI have consistently impacted the broader market, as they fundamentally alter the profitability equations for a significant portion of the financial sector. The resulting contraction in credit availability in certain segments has implications for consumer spending and economic growth, particularly in sectors dependent on easy consumer credit access.
Shift in RBI's Rupee Management Strategy
A notable shift in the RBI's currency management approach became apparent following the appointment of Sanjay Malhotra as the new Governor on December 11, 2024. Under his leadership, the central bank appeared to adopt a more flexible stance toward the rupee's valuation against the US dollar, marking a significant departure from the previous administration's policy. The former Governor, Shaktikanta Das, had favored maintaining a "very stable rupee against the US dollar," intervening consistently in foreign exchange markets to prevent sharp depreciation. In contrast, Governor Malhotra indicated openness to greater flexibility in the rupee's valuation, allowing it to move more freely in coordination with regional peer currencies.
This policy evolution reflected a strategic recalibration by the RBI to balance market stability with resource conservation. By allowing the rupee to depreciate in a controlled manner, the central bank could potentially reduce pressure on its foreign exchange reserves while permitting the currency to find a more market-determined equilibrium. The shift was also interpreted as an acknowledgment of the rupee's overvaluation based on the Real Effective Exchange Rate (REER) - a measure of the currency's value relative to a basket of other currencies, adjusted for inflation. This more market-oriented approach aligned India's currency management more closely with global trends while addressing domestic liquidity concerns.
Recent Rupee Depreciation Trends
The change in the RBI's intervention strategy coincided with a significant acceleration in the rupee's depreciation against the US dollar. In the first two months of 2025 alone, the rupee lost more value than it had through the entirety of 2024. Specifically, the rupee depreciated by 1.8 percent against the dollar in early 2025, compared to just 1.5 percent in all of 2023 and 3 percent throughout 2024. This precipitous decline culminated in the rupee reaching a historic low of 86.70 against the dollar on January 13, 2025, marking one of the steepest single-day falls in two years.
The depreciation continued into February, with the rupee breaching the 87 mark and eventually approaching 88 per dollar. On February 10, 2025, the rupee hit a new low of 87.95, prompting intervention from the central bank. By this point, the rupee had depreciated by 4.65 percent against the dollar in the current financial year and 2.13 percent in the calendar year 2025. This accelerated depreciation reflected both the RBI's more hands-off approach and mounting external pressures, including Donald Trump's trade policies and their potential implications for global trade dynamics.
Intervention Strategies and Reserve Management
Despite adopting a more flexible stance toward the rupee, the RBI has not completely abandoned intervention in the foreign exchange market. When the rupee approached the psychologically important threshold of 88 per dollar in February 2025, the central bank stepped in decisively. Reports indicate that the RBI intervened twice on February 10, first when the rupee reached 87.95 and again at the 87.60 level. The estimated scale of this intervention was between $2 billion and $3 billion, sufficient to help the rupee recover and settle at 87.48 per dollar by the end of the trading day.
This episode illustrates the RBI's evolving strategy of allowing greater flexibility within certain bounds while preventing excessive volatility or precipitous declines. Market participants described this as "two-way intervention," suggesting that the central bank was not only selling dollars to support the rupee when it weakened excessively but also buying dollars when the rupee strengthened, effectively managing the currency within a wider but still controlled range. This approach represents a more nuanced currency management strategy that permits greater market influence while retaining tools to prevent disorderly market conditions.
The cost of this currency management has been significant in terms of foreign exchange reserves. India's forex reserves declined by approximately $79 billion between September 2024 and January 10, 2025, falling to $625.87 billion. This reduction was attributed to both dollar sales to manage the rupee and substantial foreign investor withdrawals amounting to over ₹1,43,000 crore during this period. The drain on reserves has implications for domestic liquidity, pushing the banking system into a deficit despite the RBI's efforts to inject liquidity through Cash Reserve Ratio (CRR) cuts and bond purchases.
Monetary Policy Developments and Market Response
On February 7, 2025, the RBI's Monetary Policy Committee announced a 25 basis point reduction in the repo rate, lowering it from 6.50 percent to 6.25 percent. This marked the first rate cut in five years and the first policy decision under Governor Sanjay Malhotra's leadership. The rate cut decision was unanimous among committee members, sending a clear signal to markets that the central bank was concerned about slowing economic growth and was prepared to take action to stimulate activity. Despite this accommodative move, the RBI maintained a "neutral" stance rather than shifting to an explicitly accommodative policy posture, indicating that while it recognized growth challenges, it remained vigilant about inflation risks.
The central bank's inflation outlook provided some justification for the rate cut. The RBI projected retail inflation at 4.2 percent for the upcoming financial year, lower than the estimate of 4.8 percent for the current year. This forecast suggested inflation was gradually coming under control, creating space for monetary easing without compromising the RBI's inflation targeting mandate. However, the projection was contingent on normal monsoon conditions, highlighting the continued importance of agricultural output and food prices in India's inflation dynamics.
The immediate market response to the February rate cut was muted, with the Sensex briefly dipping by 100 points and the Nifty slipping below the 23,600 mark following the announcement. The rupee had opened slightly stronger ahead of the policy decision, gaining 0.1 percent in anticipation of the widely expected rate cut. This relatively subdued reaction suggests that the rate cut had been largely priced into market expectations and that investors were more focused on the RBI's forward guidance and stance than on the rate decision itself.
The combination of increased risk weights for unsecured lending and the shifting approach to rupee management has created significant challenges for certain market segments. Banking and financial stocks, particularly those with high exposure to unsecured retail lending, faced pressures on profitability and growth prospects as a result of the higher capital requirements. For export-oriented sectors, the rupee's depreciation potentially offered some competitive advantages in global markets, while import-dependent industries faced rising input costs that compressed margins.
The financial market's response to these policy shifts must also be viewed in the context of global developments, particularly U.S. trade policies under President Trump. The announcement of 25 percent tariffs on steel and aluminum imports into the United States, on top of existing duties, triggered fears of escalating trade tensions that could further pressure emerging market currencies like the Indian rupee. These external factors compounded the effects of domestic policy changes, contributing to market volatility and sectoral rotations as investors reassessed risk exposures.
Broader Economic Implications
The RBI's policy actions reflect a delicate balancing act between ensuring financial stability and supporting economic growth. The increase in risk weights for unsecured lending represented a preemptive measure to strengthen the financial system's resilience against potential asset quality deterioration in high-growth, high-risk segments. By requiring banks and NBFCs to hold more capital against these exposures, the RBI aimed to build additional buffers that could absorb losses in the event of rising delinquencies. This prudential approach prioritized financial stability but inevitably created some drag on credit expansion and economic activity in the short term.
Similarly, the central bank's evolving approach to rupee management attempts to balance multiple objectives. A more flexible exchange rate can serve as a shock absorber for the economy, helping to adjust to external pressures without depleting foreign exchange reserves. However, excessive depreciation can fuel imported inflation, particularly for essential commodities like oil, potentially complicating the RBI's inflation management task. The central bank's intervention when the rupee approached 88 per dollar demonstrates its commitment to preventing disorderly market conditions while allowing greater exchange rate flexibility within acceptable bounds.
The February 2025 rate cut signaled the RBI's recognition that economic growth concerns had become sufficiently pronounced to warrant monetary accommodation despite ongoing inflation vigilance. This recalibration of priorities suggests the central bank was responding to signs of slowing domestic demand and was prepared to support growth while maintaining its credibility on inflation control. The decision to maintain a neutral stance rather than shifting to an explicitly accommodative posture indicates a measured approach, keeping options open for future policy adjustments depending on evolving economic conditions.
Interplay with Global Economic Factors
India's economic and policy environment is increasingly influenced by global developments, particularly U.S. trade and monetary policies. The Trump administration's tariff announcements and their potential impact on global trade flows have contributed to pressure on the rupee and heightened market volatility. These external factors complicate the RBI's policy choices, as the central bank must consider not only domestic conditions but also potential spillovers from global economic shifts.
The rupee's depreciation trajectory is significantly influenced by the strength of the U.S. dollar, which in turn responds to expectations about U.S. Federal Reserve policy and the broader economic agenda of the Trump administration. Analysts had projected the rupee to depreciate to around 87 per dollar by March 2025, though the currency reached this level earlier than anticipated due to the confluence of domestic policy shifts and external pressures. The interplay between these domestic and global factors creates a complex environment for investors, businesses, and policymakers alike.
Ending Note
The RBI's recent policy decisions regarding risk weights for unsecured lending and rupee management reflect a nuanced approach to addressing financial stability concerns while navigating complex global economic conditions. Under Governor Sanjay Malhotra, the central bank has demonstrated a willingness to recalibrate established policies, allowing greater exchange rate flexibility while maintaining vigilance against excessive market volatility. The February 2025 rate cut further illustrates the evolving policy framework, balancing growth support with inflation management.
These policy shifts have created both challenges and opportunities for different segments of the Indian equity markets. Financial sector stocks have faced pressure from higher capital requirements for unsecured lending, while export-oriented sectors have potentially benefited from rupee depreciation. The broader market has needed to adjust to these evolving dynamics, leading to sectoral rotations and periodic volatility as investors reassess the implications for corporate earnings and economic growth.
Looking ahead, the RBI's policy direction will continue to be shaped by both domestic considerations and the evolving global economic landscape. The central bank's ability to maintain financial stability while supporting economic growth will be crucial in determining the trajectory of Indian equity markets in the coming months. Investors will need to closely monitor both policy signals from the RBI and external developments, particularly U.S. trade policies and their potential ripple effects on global trade and capital flows.
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