Sharp rise in unsecured loans may push credit costs: India Ratings

The unsecured loan book saw higher credit losses during the pandemic, however on a steady state basis, the losses can range between 4-8%

India Ratings warns that non-banking finance companies (NBFCs), particularly fintechs focusing on unsecured loans, might face heightened credit costs. These entities have been increasingly pursuing unsecured loans for higher yields in an intensely competitive market.

During the financially challenging period marked by the Covid-19 pandemic in FY21 and FY22, NBFCs exhibited caution in expanding their loan portfolios. However, FY23 witnessed a rebound in their assets under management (AUM).

Based on data from large NBFCs (with AUM totalling Rs 10.3 trillion as of March 2023), AUM grew by 19 per cent on a year-on-year basis in FY23, in contrast to a 3.3 per cent growth in FY21 and 9.6 per cent in FY22.

The unsecured loan segment experienced higher credit losses during the pandemic. Nevertheless, on a steady-state basis, these losses can range between 4-8 per cent.

The rating agency's estimate reveals that the credit costs of pure-play unsecured lenders escalated from 6.5 per cent in FY19 to 11.0 per cent in FY22. Due to the financial clean-up during the pandemic, credit costs decreased to 6 per cent in FY23.

Fintechs, still in the process of refining their underwriting models and operating with high expenses, find it challenging to absorb credit losses.

The fintech business model also necessitates maintaining the disbursement rate since their earnings are predicated on fee income and spread income based on the volume of disbursements. Consequently, any slowdown could impact profitability given their current operational scale. According to India Ratings, some fintechs are operating at a loss, and further credit losses could erode their capital.

The credit profiles of unsecured loan borrowers from large NBFCs may be slightly better than those of their fintech counterparts. However, this could still prompt an increase in credit cost estimates.