Financial sector must avoid 'all forms of exuberance': RBI governor

Sound caution on credit growth, model-based lending, high-interest rates charged by MFIs, contagion risks

From banks’ reliance on high-cost deposits to model-based loans offered by fintech firms, contagion risks, and high-interest rates charged by microfinance institutions, Reserve Bank of India (RBI) Governor Shaktikanta Das on Wednesday cautioned various financial sector entities on a host of issues. He told banks and non-banking financial institutions (NBFCs) that “all forms of exuberance” should be avoided.

“At the current juncture there may not be any immediate cause for worry, but to remain on top of things, banks and NBFCs would be well advised to take certain precautionary measures,” he said while speaking at the annual Ficci-IBA (Indian Banks' Association) conference here. He highlighted that the recently implemented stringent regulations on unsecured lending were designed to promote sustainability in the financial sector. “We have recently announced a few macro-prudential measures in the overall interest of sustainability,” Das said.

The RBI governor further said: “These measures are pre-emptive in nature, they are calibrated and targeted.”

He further clarified that exemptions were granted to specific segments like housing loans, vehicle loans, and small business credits due to their positive impact on economic growth.

The surge in unsecured loans, such as personal loans and credit card spends, prompted the RBI to increase the risk weighting for such loans from 100 per cent to 125 per cent. The risk weighting for bank loans to higher-rated NBFCs was also increased by 25 percentage points.

Das outlined four areas where financial sector entities need to exercise caution.

“First, while credit growth is accelerating in the current period, banks and NBFCs may take due care to ensure that credit growth at the overall, sectoral and sub-sectoral levels remain sustainable, and all forms of exuberance are avoided,” he said.

The RBI governor asked banks for greater attention to the liabilities side and the need to strengthen asset liability management. “In certain cases, we have observed increased reliance on high-cost short-term bulk deposits, while the tenure of loans, both retail and corporate loans, is getting elongated.”

Further, he warned that the increasing interconnectedness between banks and NBFCs posed a contagion risk. He said banks must continually evaluate their exposure to NBFCs and vice versa. “NBFCs on their part should focus on broad-basing their funding sources and reducing over-dependence on bank funding,” Das said.

He also asked the microfinance institutions (MFIs) to refrain from charging usurious interest rates. “Though the interest rates are deregulated, certain NBFCs-MFIs appear to be enjoying relatively higher net interest margins. It is indeed for microfinance lenders to ensure that the flexibility provided to them in setting interest rates is used judiciously. They are expected to ensure that interest rates are transparent and not usurious,” he advised.

Finally, he had a word of caution for the fintech sector. The RBI governor said algorithm-based lending models should be tested periodically and needed to be watched for any build-up of risks due to information gaps. “An important aspect that merits attention in this context is with regard to model-based lending through analytics. Banks and NBFCs need to be careful in relying solely on pre-set algorithms... These models should be robust and tested and re-tested periodically,” he said.

About the agriculture sector, he said its performance is expected to remain robust in 2023-24 despite challenges, such as an uneven southwest monsoon and lower kharif production. The ongoing diversification of exports, both in terms of products and destinations, is bolstering the economy's resilience to shocks, Das said. 

He further noted that the agricultural sector remains a significant source of employment for a substantial portion of the workforce.

Although headline inflation suggests a cooling trend, Das reiterated the RBI’s steadfast commitment to addressing concerns related to rising prices. 

The RBI governor said the rupee has displayed minimal volatility and well-organised movements compared to its counterparts, even in the face of heightened US Treasury yields and a stronger US dollar. Das’ comment came at a time when the rupee has been hitting new lows.