Unsecured risk

Retail loan growth needed to be checked

In a pre-emptive move, the Reserve Bank of India (RBI) last week increased risk weighting in consumer credit for both banks and non-banking financial companies (NBFCs) from 100 per cent to 125 per cent. This will, however, not include housing loans, education loans, vehicle loans, and gold loans. The banking regulator was clearly worried about the growth in unsecured loans. Risk weighting has also been increased for credit-card receivables. RBI Governor Shaktikanta Das touched upon the issues in his monetary policy statement in October and advised banks and NBFCs to strengthen their internal surveillance.
 

The Indian economy has witnessed a surge in consumer-credit growth over the past couple of years. Retail loans grew at a compound annual rate of 24.8 per cent between March 2021 and March 2023, which was around double the rate of overall loan growth. Besides, during the same period, the composition of secured and unsecured advances changed, with unsecured retail loans increasing from 22.9 per cent to 25.2 per cent. The latest Financial Stability Report of the RBI also highlighted the risk in this context and noted that 10 per cent of retail borrowers were missing their monthly payments. The rise in unsecured loans has been attributed to improved underwriting capabilities, digitisation, and the use of fintech, all of which have made lending easier, but may also have increased risks. NBFCs in particular have been using digital channels aggressively.
 

As a recent report from the Centre for Advanced Financial Research and Learning showed, NBFC credit had steadily increased from 8.6 per cent of gross domestic product in 2013 to 12.3 per cent in 2022. This was accompanied by a decline in the share of credit extended by banks. Also, a significant portion of loans extended by the NBFCs is towards the retail sector. In the retail space, NBFCs’ market share expanded nearly 1.8 times between 2015 and June 2022. However, a possible increase in risk in the NBFC sector can also affect the banking system because of its reliance on bank funding. As of March 2023, over 40 per cent of NBFCs’ funding came from bank borrowing. While consumer credit has gained traction and the financial sector remains robust, there is a need to guard against possible risks to the economy, which has rightly prompted the RBI to increase capital requirements. Higher capital requirements usually translate into costlier borrowing, which could not only affect demand for credit but also profitability in the financial sector. This was reflected in the decline in the share prices of banks and other related financial institutions after the RBI’s announcement.
 

The use of fintech in lending often depends on the cash flow of the small borrowers. It is possible that the generation and use of financial data in digital form are enabling fintech companies, backed by banks and NBFCs, to extend credit to the section of borrowers who were hitherto excluded from the formal financial sector. It is also worth examining if all such loans are being taken to fund consumption or used for small household enterprises. Increased unsecured lending by banks and NBFCs thus needs to be studied more closely. However, from a regulatory standpoint, sustained higher growth in consumer credit was a clear red flag for the RBI. Its regulatory intervention will help contain credit growth and possible risks.