Finally, it happened. Even though the heads of public sector banks (PSBs) have not been losing sleep over unsecured small loans turning bad as they form a minuscule part of their overall credit book, the Reserve Bank of India (RBI) doesn\u2019t want to take any chance. Last week, it raised the risk weight for consumer loans, barring housing, education, vehicle and gold loans, and loans given to microfinance entities and self-help groups by banks and non-banking financial companies (NBFCs) by 25 percentage points. This will increase the cost of capital for such loans for lenders and discourage them from going overboard.<\/p>\n
Earlier,<\/strong>\u00a0in the October monetary policy statement, while emphasising on the importance of financial sector stability, RBI Governor Shaktikanta Das spoke about the very high growth of certain components of personal loans. The RBI has been closely monitoring them for any signs of incipient stress.<\/p>\n \u201cBanks and NBFCs would be well advised to strengthen their internal surveillance mechanisms, address the build-up of risks, if any, and institute suitable safeguards in their own interest,\u201d Das said, adding, \u201cThe need of the hour is robust risk management and stronger underwriting standards.\u201d<\/p>\n Deputy Governor Swaminathan J, too, pointed out that unsecured loans have been an \u201coutlier\u201d, growing at 23 per cent in the past two years, while other segments such as loans to corporations and small and medium enterprises have been growing at 12-14 per cent.<\/p>\n Amid growing concerns over the ability of small borrowers to service loans, the finance ministry had asked the PSBs to review their small loan portfolios and submit a report on the state of affairs in this segment. The bankers have assured the ministry that they do not see any systemic risks emanating from small unsecured loans as their overall exposure remains tiny.<\/p>\n The risk weight is an instrument, often used by the banking regulator, to rein in lenders\u2019 over-enthusiasm in giving certain types of loans. For instance, when rising exposure to the real estate sector created concerns about asset quality and the potential systemic risks, the risk weight on banks\u2019 exposure to commercial real estate was increased from 100 per cent to 125 per cent in July 2005 and further to 150 per cent in April 2006. Before that, the risk weight on housing loans was increased from 50 per cent to 75 per cent in December 2004. These were done by former RBI Governor Y V Reddy. He also increased the risk weight for consumer credit and banks\u2019 capital market exposures from 100 per cent to 125 per cent.<\/p>\n According to the RBI\u2019s latest Financial Stability Report, released in June, advances for unsecured retail loans rose to 25.2 per cent in March 2023 from 22.9 per cent in March 2021 while the secured loans saw a decline to 74.8 per cent from 77.1 per cent during the same period. Overall, retail\u00a0loans grew at a compound annual growth rate or CAGR of 24.8 per cent from March 2021 to March 2023 in contrast to 13.8 per cent CAGR for overall bank credit.<\/p>\n Ahead of that, an RBI publication titled\u00a0Report on Trends and Progress of Banking in India<\/em>\u00a0in December 2022 warned that retail loans could become a \u201csystemic risk\u201d.<\/p>\n \u201cIn recent years, Indian banks appear to have displayed \u2018herding behaviour\u2019 in diverting lending away from the industrial sector towards retail loans. The decline was evident across bank groups. Empirical evidence suggests that a build-up of concentration in retail loans may become a source of systemic risk,\u201d the report observed.<\/p>\n Let\u2019s take a closer look.<\/p>\n Delinquencies, measured in terms of the inability of borrowers to\u00a0repay\u00a0loans\u00a0between 31 and 180 days, for loans under Rs50,000 rose to 8.1 per cent in June 2023, credit bureau CRIF Highmark\u2019s data show.<\/p>\n Technically, a loan turns into special mention account 1 (SMA-1) if the borrower has not paid the repayment instalment within 30 days; SMA-2 for non-payment over 60 days; and a non-performing asset (NPA) when the repayment is not done even after 90 days.<\/p>\n Essentially, loans belonging to the SMA-1 and SMA-2 have been growing.<\/p>\n The bad loans in the retail segment were 1.4 per cent as of March 2023.<\/p>\n Going by the CRIF Highmark data, the total value of short-term personal loans (STPL) below Rs10,000 grew 37 per cent in the financial year ending March 31, 2023, while STPL of Rs10,000-50,000 rose 48 per cent. The credit bureau considers loans up to Rs50,000 as STPL.<\/p>\n Some 8.6 million such loans were disbursed in FY23, registering a 50 per cent rise over FY22. About 80 per cent of all personal loans disbursed in FY23 were STPL and 60 per cent of such loans had an ultra-small ticket size \u2014 below Rs10,000.<\/p>\n The overall personal loan portfolio was to the tune of Rs11.16 trillion as of June 2023 \u2014 more than double of the level seen in March 2020 (pre-Covid).<\/p>\n Small cities are contributing more to these loans. About 38 per cent of STPL up to Rs10,000 in the last 12 months were outside India\u2019s top 100 cities. In contrast, 29 per cent originated in the top eight cities.<\/p>\n To support the fact that small cities are playing a bigger role in this segment, the credit bureau says 35 per cent of STPL between Rs10,000 and Rs50,000 sanctioned between July 2022 and June 2023 were from beyond the top 100 cities while the top eight cities accounted for 31 per cent.<\/p>\n NBFCs dominate the origination and the portfolio of such loans. The share of private banks by origination volume has risen from the pre-Covid level, but relative to March 2022 it has dipped.<\/p>\n An October report of Swiss brokerage UBS red-flagged the issue, saying the PSBs may see higher defaults than their private peers, as credit losses from unsecured retail loans could increase 50-200 basis points in 2024-25. One basis point is a hundredth of a percentage point. \u201cState-owned banks likely had 52 per cent of their outstanding personal loans to borrowers with credit scores below 644 (medium- to high-risk borrowers), while NBFCs had 49 per cent and large private banks about 31 per cent in June 2023,\u201d the report pointed out.<\/p>\n Finally, the phenomenon of over-leveraging.<\/p>\n A November 2 report of credit bureau TransUnion CIBIL discusses how the profile and preferences of borrowers have been changing \u2014 more consumers seeking multiple credit products within a short time span. Its Credit Market Indicator report for the quarter ending June 2023 talks about a healthy retail credit growth and broadly stable delinquency level even as a few pockets are showing signs of risk build-up. Stress is seen at credit cards and personal loans.<\/p>\n Since January 2022, small-ticket personal loans of less than Rs50,000, while representing a very small share of total retail balances, have roughly accounted for one-fourth of total volumes. In the June quarter of FY24,\u00a051 per cent of consumers\u00a0who took small-ticket personal loans already had more than four credit products at the\u00a0<\/strong>time of accessing yet another new loan, compared with just 17 per cent in the June quarter of FY20.<\/p>\n There are other signs that reveal everything is not hunky-dory. A recent study by SBI Life Insurance, in collaboration with Deloitte, finds that 47 per cent of individuals surrendered their life insurance policies in the last five years. Meanwhile, the absolute number of Income Tax returns filers is rising but the number of taxpayers is going down.<\/p>\n Whether we like it or not, clearly there is stress in the space of unsecured borrowers. Who is responsible for the over-leveraging? NBFCs? Fintechs? Where do they get the money to lend?<\/p>\n The RBI has not kept its eyes closed to the warning signals of stress that built up. Rightly so. But I am just curious about the timing of the action.\u00a0Swaminathan ruled out any regulatory prescription such as\u00a0an increase in risk weight last month. \u201cWe would expect banks, NBFCs and fintechs to act as a first line of defence,\u201d he said. Certainly the regulator knows more than what we do. Have the September quarter data\u00a0(<\/strong>not available to public as yet)\u00a0shown further rise in personal loans and delinquencies, despite the RBI warnings?<\/p>\n This column first appeared in\u00a0<\/strong>Business Standard.<\/strong><\/em><\/p>\n The writer, a Senior Adviser to Jana Small Finance Bank, writes Banker’s Trust every Monday in\u00a0<\/strong>Business Standard.<\/strong><\/em><\/p>\n