Why is it in the News?

Context:

• The Reserve Bank of India (RBI) recently issued regulatory measures to banks and NBFCs to increase risk weights associated with consumer credit and bank credit by an additional 25 percentage points.
• Currently, at 100% risk weight, loans to consumers will see an increase to 125%, excluding loans for housing, education, vehicles, and against gold.
• This would be applicable to unsecured personal loans, credit cards, and lending to NBFCs.
• The directions are expected to result in higher capital requirements for lenders and thereby, an increase in lending rates for consumers.

What is ‘Risk Weights'?

• Risk weight is capital required to be set aside, stipulated by the Reserve Bank of India for Banks, or National Housing Bank for housing finance companies, that has to be made by banks for giving the loan.
• In other words, it is the amount (depicted as a percentage of loan disbursed) that institutions need to set aside for assets.
• The risk weight is a function of the risk perception the apex bank has on loans for different sectors.
• It is applicable to all categories of retail (personal, home, car, and education loans) as well as corporate lending.
• The one that often impacts borrowers directly, and the most, is the risk weight on home loans.
• It is an essential tool for banks to manage this risk.

Why do risk weights matter?

• Risk weights are pivotal in banking regulation, as they dictate the capital set aside for different loan types, reflecting their risk profiles.
• Unsecured loans, perceived as riskier, have higher weights, thus requiring more capital.
• Home loans, for instance, attract a risk weight of 35-50%, depending on the size of the loan.
• In comparison, personal loans will now have a risk weight of 125%.

Why were the Changes by RBI Deemed Necessary?

• Governor Shaktikanta Das had flagged concerns about the “high growth” in “certain components of consumer credit.” while presenting the monetary policy statement in October this year.
• He advised banks and NBFCs to “strengthen their internal surveillance mechanisms, address the build-up of risks, if any, and institute suitable safeguards, in their own interest.”
• The governor said these were being closely monitored by the apex banking regulator for “any signs of incipient stress.”
• Rating agency Moody’s also put forth that higher risk weights are intended to “dampen lenders’ consumer loan growth appetite.”
• The unsecured segment, it adds, has grown rapidly in the past few years, exposing financial institutions to a potential spike in credit costs in the event of a sudden economic or interest rate shock.
• RBI’s latest figures stipulate that unsecured personal loans have increased approximately 23% on a year-over-year basis, as of September 22 this year.
• Outstanding loans from credit cards increased by about 30% during the same period.
• Major concerns emerge for loans below Rs 50,000 – these carry the utmost default risk.
• Delinquencies in this segment stood at 5.4% as of June this year.
• Ratings agency S&P in their assessment held that borrowers in this segment are often highly leveraged and may have other lending products.
• According to Moody’s, several NBFCs that until now focused on secured lending categories (such as infrastructure, real estate, and vehicle loans) have pivoted to riskier segments.

What are the main concerns?

• The primary concerns are about how these changes might affect the amount of money banks have and how well they can make a profit.
• Having enough money, called capital adequacy, is crucial for banks.
• It helps them handle unexpected problems or risks in their business without losing too much money.
• A recent report from S&P, which is a group that studies these things, says that if banks are more careful and focus on managing risks, it could make their loans safer.
• However, it predicts that a measure called Tier-1 capital adequacy, which is like the best kind of money banks have, might go down a bit—about 60 basis points.
• This is important because Tier-1 capital helps banks deal with losses right away.
• S&P thinks that this might make banks that don't have a lot of this kind of money think about getting more.
• Also, it noticed that government-owned banks generally have less of this important money than big private banks.
• But, the report says that finance companies might face the biggest impact because they could end up borrowing more from banks, and it might affect how much good money they have.

How It will affect Consumers?

• As the risk weightage goes up, banks may become more careful about giving loans to consumers, especially those seen as having a higher risk.
• This could make it harder for some people to get credit cards or personal loans.
• Even those who still qualify for credit might face stricter terms and conditions.
• Experts suggest that by increasing the risk weightage, the RBI is trying to handle the increasing number of people not repaying their loans and the risks connected to unsecured loans.
• Lenders will now have to consider the higher credit risk in this type of loan, which could make lending more expensive.
• As a result, borrowers taking out these loans may face higher costs.

Way Forward

Banks and NBFCs may need to review their approaches to risk and lending specifically for unsecured loans. This could involve placing greater emphasis on evaluating creditworthiness and exploring alternative strategies to effectively handle risk while still providing loans. Financial institutions might also consider diversifying their loan portfolios by placing more emphasis on secured lending or exploring other creditworthy segments. This approach aims to balance the effects of the heightened risk-weighting associated with unsecured loans.

What is the Capital Adequacy Ratio (CAR)?

• The Capital Adequacy Ratio (CAR) is a financial metric used to evaluate a bank's stability and risk management.
• Calculated as a percentage, it compares a bank's capital—comprising Tier-1 and Tier-2 capital—to its risk-weighted assets.
• Tier-1 capital includes core elements like common equity
• Tier-2 capital consists of supplementary items.
• Regulatory authorities, such as the RBI, establish minimum CAR requirements to ensure banks can absorb potential losses.
• A higher CAR reflects greater financial resilience, emphasizing a bank's ability to navigate economic challenges and adhere to regulatory standards.

Why in the News?

As many as 38 companies, including big names like Foxconn Group, HP, Dell and Lenovo, have applied for incentives under the mega Production Linked Incentive (PLI) IT hardware scheme for manufacturing laptops, PCs and servers.

Context:

• In addition to Asus, Dell, HP, and Foxconn, several other companies, including Lenovo, Acer, and Flex, have submitted applications for the scheme. Notably, Flex is reportedly involved in manufacturing Reliance's JioBook laptop.
• HP Enterprises (HPE) has also sought approval for server manufacturing operations within India.
• Although the expected incremental production over the scheme's six-year duration is projected to reach Rs 3.35 lakh crore, the anticipated additional investment during this period is relatively modest, at just Rs 4,000 crore.
• The government anticipates that the manufacturing activities enabled by the scheme will create approximately 75,000 direct jobs, with the potential to generate up to 2 lakh indirect jobs when considering the broader economic impact.

What is the PLI Scheme?

• The PLI scheme was created to boost domestic manufacturing, reduce reliance on imports, and create more jobs.
• The government has allocated Rs 1.97 lakh crore for various sectors under the PLI schemes, with an additional Rs 19,500 crore designated for PLI in solar PV modules in the 2022-23 Budget.
• Initiated in March 2020, the scheme initially focused on three industries:
• Mobile and allied Component Manufacturing
• Electrical Component Manufacturing
• Medical Devices
• Incentives Under the Scheme:
• The incentives, based on increased sales, vary from 1% for electronics and technology products to 20% for critical key starting drugs and certain drug intermediaries.
• In some sectors like advanced chemistry cell batteries, textile products, and the drone industry, incentives are calculated based on sales, performance, and local value addition over a five-year period.
• Sectors Covered by the PLI Scheme:
• The government has introduced PLI schemes for 14 sectors, including automobiles and auto components, electronics and IT hardware, telecom, pharmaceuticals, solar modules, metals and mining, textiles and apparel, white goods, drones, and advanced chemistry cell batteries.
• Objectives:
• The government introduced this scheme to reduce India's dependence on foreign countries, particularly China.
• It aims to support labor-intensive sectors and increase employment in India while reducing import bills and promoting domestic production.
• The PLI Yojana also encourages foreign companies to establish operations in India and domestic enterprises to expand their production facilities.

What is the PLI scheme for IT Hardware?

• The PLI scheme for IT Hardware was initially announced in February 2021, with an initial allocation of approximately Rs 7,300 crore over a four-year period.
• Incentive Structure:
• Under this scheme, domestic companies that invest Rs 20 crore and achieve sales of Rs 50 crore in the first year, Rs 100 crore in the second year, Rs 200 crore in the third year, and Rs 300 crore in the final year can receive incentives ranging from 1% to 4% on incremental sales compared to the base year of 2019-20.
• Revised Version:
• The initial version of the scheme had limited success, with only two companies, Dell and Bhagwati, meeting the first-year targets.
• Consequently, the industry called for a revamped scheme with a larger budget.
• In response, the Union Cabinet approved a revised PLI scheme for IT hardware in May 2023, allocating Rs 17,000 crore, more than doubling the budget.
• Potential Impact:
• PLI 2.0 has the potential to attract major global IT hardware manufacturers to establish their production operations in India, bolstering the local production of laptops, servers, personal computers, and more.
• Over a six-year period, the average incentive is expected to be around 5%, compared to the previous 2% over four years.
• Achieving Digital Economy Goals:
• With the IT hardware industry aiming for a production value of $24 billion by 2025-26 (with exports estimated at $12-17 billion), this scheme plays a crucial role in realizing the goal of a $1 trillion digital economy, including $300 billion from electronics manufacturing by 2025-26.

How Will the PLI Scheme Drive Local Production in India?

• Despite identifying electronics manufacturing as a pivotal sector for future economic growth, India has witnessed a surge in the import of electronic goods in recent years.
• Import Scenario:
• For instance, the import of electronic goods surged to $6.96 billion during April-June this year, up from $4.73 billion in the same period last year, constituting 4-7% of overall imports.
• The category with the highest import share includes personal computers, including laptops and palmtops.
• China Dominance:
• China commands a significant portion, approximately 70-80%, of India's imports in the personal computer and laptop category.
• Incentives for Component Manufacturers:
• Companies engaged in local manufacturing of specific components like memory modules and display panels will receive supplementary incentives under the revised scheme.
• Performance-Driven Approach:
• The PLI scheme is designed to encourage companies to meet production targets.
• If companies fall short of these thresholds, they may face deductions of up to 10% from their subsidies.
• Synergy with Semiconductor Scheme:
• The PLI scheme will complement the government's semiconductor scheme, with domestically produced chips finding application in laptop manufacturing, further bolstering the local industry.

Mains Question:

• Discuss the impact of the PLI Scheme for IT Hardware on the Indian electronics manufacturing sector. Evaluate its effectiveness in reducing imports and critically assess its potential to stimulate job growth in the country. (15M)