Fitch warns rapid growth in unsecured retail credit needs management

Operating environment for Indian banks improved as economic risk recede

Global rating agency Fitch on Wednesday warned that rapid loan growth, especially in unsecured retail credit, needs careful management to avoid a spike in risks and credit costs for banks and finance companies.

India’s private credit/GDP ratio, which is at around 57 per cent in 2022, is already moderately higher than the median for sovereigns in the ‘BBB’ category, of 50 per cent.
 

In June, Reserve Bank of India’s (RBI) Financial Stability Report (FSR) put the spotlight on the increase in unsecured retail credit.
 

The retail loans grew at a compounded annual growth rate (CAGR) of 24.8 per cent from March 2021 to March 2023, almost double the CAGR of 13.8 per cent for gross advances during the same period.

The composition of secured and unsecured advances has changed during this period, with unsecured retail loans increasing from 22.9 per cent to 25.2 per cent and secured loans declining from 77.1per cent to 74.8 per cent.

Unsecured retail loans constituted only 7.9 per cent of the total banking system credit.

Moreover, their asset quality has improved, with Gross non-performing Assets (GNPAs) ratio declining from 3.2 per cent to 2.0 per cent during this period.

Notwithstanding the few signs of potential stress in retail loans, they do not pose an imminent risk to systemic stability, the FSR said.

Saswata Guha, senior director, Financial Institutions (Banks), Fitch Ratings said that while personal loans are high margin business, the concern is about whether the lenders are pricing unsecured loans appropriately, given the stiff competition.

Both credit underwriting standards and adequacy of buffers to withstand shocks needs to be watched.

At present, caution is warranted because first, tolerance buffers, though improved, may not be adequate across the board, and second, banks have had a volatile track record through the cycle performance.

It is still early to conjecture how the present cycle will unfold, Guha added.

The operating environment (OE) for Indian banks has strengthened as economic risks associated with the Covid-19 pandemic have ebbed, said Fitch Ratings.

A number of prudential indicators for the sector have also improved compared with pre-pandemic levels, though growing risk appetite in a relatively benign OE highlights the importance of appropriate buffers against potential stress, it added.

Meanwhile, rating agency ICRA, said that for the non-banking finance companies, the unsecured loan segment consisting of personal and consumption loans, unsecured small enterprise loans and microfinance loans, fuelled the expansion of the retail segment in the current financial year.

Unsecured loans grew at a CAGR of 27 per cent during the five-year period ended March 2023 compared to 11 per cent for secured loans, it added.