The NBU is introducing increased risk weights for unsecured consumer loans issued by banks. Risk weights will be raised in two stages:
- to 125% on 1 July 2021
- to 150% on 1 January 2022.
This increase will prompt banks to hold enough capital for covering unexpected losses caused by a deterioration in the quality of the unsecured consumer loan portfolio. The quality of this portfolio depends heavily on changes in macroeconomic conditions, and this relationship may be underestimated by banks when determining expected losses on these loans.
Higher risk weights will increase banks’ resilience to potential crisis episodes and protect the sector from the accumulation of systemic risks, thus helping maintain financial stability (consumer credit risks are covered in detail in the December Financial Stability Report). The consumer lending segment will remain attractive to banks, but they will pursue more prudent loan policies.
As previously reported, consumer loan risk weights of 100% and minimum regulatory capital adequacy requirements of 10% imply that for every UAH 10 in loans, a bank must hold UAH 1 in capital. The two-stage increase in risk weights to 150% will raise the capital requirements of banks active in the consumer lending segment by 1.5 times, to UAH 1.5, creating a buffer of UAH 0.5 against adverse conditions. This will expand the share of unsecured consumer loans that banks finance with equity rather than deposits.
The decision to raise risk weights for unsecured consumer loans was approved by NBU Board Resolution No.1 On Amendments to the Instruction on the Procedure for Regulation of Bank Activities dated 11 January 2021, and takes effect on 30 June 2021.
However, the same resolution allows banks, as of 21 February, to determine the capital requirement to cover the credit risk of off-balance sheet liabilities, given the probability of their conversion into credit assets. This probability is reflected by the Credit Conversion Factor as defined by Regulation No. 351. Thus, when determining the capital requirement, the value of off-balance sheet liabilities may be reduced to match the likelihood of their conversion into credit. This step comes against the backdrop of the implementation by the NBU of EU legislation, and it will, to an extent, balance the impact of higher risk weights.