Macroprudential policy

Indian Economy glossary

Also called: Macroprudential regulation · Topic: Banking, Credit Creation and Monetary Policy · NCERT: Beyond NCERT

Meaning

Macroprudential policy means using regulatory tools, such as capital buffers, sectoral risk weights, loan-to-value (LTV) caps and provisioning norms, to limit risk to the whole financial system, not only to one bank.

  • It matters because every bank can look safe on its own and the system can still be in danger. This happens when all banks lend heavily to the same risky sector, such as housing or unsecured loans.
  • In India, it is the RBI's main tool for financial stability. The repo rate is kept for price stability.
  • Key formulas:
  • Risk-weighted asset (RWA) = Loan amount × Risk weight
  • Capital needed = RWA × required capital ratio
  • LTV ratio = Loan amount ÷ Value of the asset × 100

Explanation

Micro vs macro: why a system-wide view is needed

  • Microprudential regulation checks whether each bank is safe on its own. It looks at that bank's capital, its bad loans and its liquidity.
  • Macroprudential policy looks at the whole system. It asks two questions:
  • Is every bank running towards the same risky segment?

  • If that segment fails, will all the banks be hit at once?

  • The problem it solves:

  • Unsecured loans (loans with no collateral behind them, such as personal loans and credit cards) are booming.
  • Every bank earns well from them, so each bank looks healthy.

  • If borrowers stop repaying, losses hit all banks together. Credit then freezes across the whole economy.

  • Macroprudential tools raise the cost of risky lending before the bust comes.

The main tools

  • Countercyclical capital buffer (CCyB): extra capital that banks must build in good times and can use in bad times.
  • Credit boom: the RBI switches on the CCyB. Banks must hold more capital, so fast lending slows and a cushion builds up.

  • Downturn: the RBI releases the buffer. Banks use it to absorb losses and keep lending instead of cutting loans.

  • Sectoral risk weights: a risk weight is a number that tells a bank how much capital to hold against a loan. A riskier loan gets a higher weight.

  • When the RBI raises the weight for one sector, each loan in that sector uses more of the bank's own money.

  • Lending to that sector becomes costlier for the bank, so it lends less or charges more.

  • Loan-to-value (LTV) caps: an upper limit on the loan as a share of the asset's value. The borrower must pay the rest from their own money.

  • If the asset's price falls, the borrower's own money takes the first loss, so the bank stays protected.

  • LTV caps are the macroprudential version of the old margin requirement. A margin requirement is the part of a security's value that a bank cannot lend against.

  • Provisioning norms: provisioning is money a bank sets aside from its profits to cover loans that may go bad.

  • Higher provisioning for risky sectors builds a loss cushion early.
  • It also makes lending to those sectors less attractive.

Worked examples

  • Sectoral risk weight (for illustration, assume a 9% capital requirement):
  • ₹100 personal loan at a 100% risk weight → RWA ₹100 → capital needed ₹9
  • The same loan at a 125% risk weight → RWA ₹125 → capital needed ₹11.25

  • Each loan now uses ₹2.25 more of the bank's own capital. Unsecured lending becomes costlier and slows down.

  • LTV cap:

  • A 75% LTV cap on a ₹1 crore house → the bank lends at most ₹75 lakh. The buyer pays ₹25 lakh from their own money.
  • If the house price falls by 20% to ₹80 lakh, the ₹75 lakh loan is still fully covered.

When the tools are tightened or loosened

  • Tighten (raise the CCyB, risk weights or provisioning, or lower the LTV cap) when credit to one segment grows too fast or when asset prices rise quickly.
  • Loosen when that risk fades or when credit growth becomes too weak.
  • So the tools move up and down with the credit cycle. They are not set once and left alone.

In India

  • Who manages it: the RBI, as the regulator of banks and NBFCs (non-banking financial companies).
  • Tools in use: sectoral risk weights, LTV caps on housing loans and gold loans, provisioning norms, and the CCyB.
  • CCyB: the framework has existed since 2015, but it has not yet been activated.
  • RBI circular of 16 November 2023 (the main recent case) [1]:
  • The risk weight on banks' consumer credit (new and existing loans) went from 100% to 125%. Housing, education, vehicle and gold-backed loans were excluded [1].
  • The risk weight on NBFCs' retail consumer credit was set at 125%. Microfinance and SHG (self-help group) loans were excluded [1].
  • Credit card receivables (money owed to lenders on credit cards) went from 125% to 150% for scheduled commercial banks, and from 100% to 125% for NBFCs [1].
  • The risk weight on bank loans to NBFCs went up by 25 percentage points above the rating-based weight, wherever that weight was below 100%. Housing finance companies, core investment companies and NBFC loans that count as priority sector were excluded [1].
  • Lenders had to set Board-approved limits for each segment of consumer credit, especially unsecured loans, and meet these credit standards by 29 February 2024 [1].

  • Top-up loans against assets that lose value, such as vehicles, must be treated as unsecured [1].

  • February 2025: these measures were partly rolled back.

  • Moral suasion first, then the rule. Moral suasion means the RBI persuades banks without a legal order. It first warned publicly about unsecured loans, then raised the risk weights.
  • Monitoring and coordination:
  • Financial Stability Report (FSR): published by the RBI twice a year, in June and December. It includes system-wide stress tests of banks.
  • Financial Stability and Development Council (FSDC): set up in 2010 and chaired by the Finance Minister. It coordinates the RBI, SEBI, IRDAI, PFRDA and IBBI.

Don't confuse with

  • Microprudential regulation: this checks that each bank is safe on its own. Macroprudential policy targets risk to the whole system.
  • Selective credit controls (SCCs, from 1956 to the 1990s): the RBI used these under Section 21 of the Banking Regulation Act, 1949 to control commodity prices and hoarding (for example foodgrains and sugar), through direct orders on margins and credit ceilings. Macroprudential policy aims at financial stability and works through capital costs, so banks still decide how to adjust.
  • Monetary policy (repo rate): the repo rate (the interest rate at which the RBI lends money to banks for a short time) affects every borrower and targets inflation. Macroprudential tools hit only the risky segment and target financial stability.
  • Quantitative tools (CRR, SLR, OMO): these change the total volume of credit. Macroprudential tools such as sectoral risk weights change the cost of credit to chosen sectors.

Prelims Hooks

  • Macroprudential policy = tools that limit risk to the whole financial system. Examples are the CCyB, sectoral risk weights, LTV caps and provisioning norms.
  • RWA = Loan × Risk weight, and Capital = RWA × capital ratio. A higher risk weight means more capital for each loan, so lending to that sector becomes costlier.
  • November 2023 [1]:
  • Consumer credit risk weight went from 100% to 125%.
  • Bank credit card receivables went from 125% to 150%.

  • Housing, education, vehicle and gold loans were excluded.

  • The CCyB framework dates from 2015 and has never been activated. Trap: statements saying India has switched on the CCyB are wrong.

  • The FSDC (2010) is chaired by the Finance Minister, not the RBI Governor. The FSR is published by the RBI twice a year (June and December).
  • The RBI applies LTV caps to housing and gold loans. LTV caps are the modern form of the margin requirement.

Mains Points

  • Targeted tool vs blunt rate (Tinbergen rule): the Tinbergen rule says that to reach N goals, a policymaker needs at least N separate instruments.
  • In India, the repo rate targets price stability and macroprudential tools target financial stability.
  • Suppose unsecured loans are booming while inflation is on target. Raising the repo rate would hurt every borrower, including MSMEs and farmers.

  • Raising risk weights on consumer credit, as the RBI did in 2023 [1], cools only the risky segment.

  • From command to prudence: India moved from direct orders (SCCs under BR Act s.21) to price-based prudential tools such as risk weights and provisioning.

  • This matches the post-1991 shift to market-based policy.

  • Banks still choose how to adjust, but the regulator changes their incentives.

  • Timing and calibration risk: tightening slows credit growth.

  • The 2023 risk-weight increase [1] was partly rolled back in February 2025. This shows the tools have to be adjusted over the credit cycle.
  • The CCyB, designed for exactly this purpose, has never been switched on since 2015. This raises questions about how ready the RBI is to act counter-cyclically, that is, to tighten in booms and ease in downturns.

Related concepts

Read more

Sources

  1. 1RBI, Regulatory measures towards consumer credit and bank credit to NBFCs (16 November 2023)rbi.org.in · tier 1