Unsecured retail loans burgeoned on banks' books in Covid-19's aftermath

On October 6, the Reserve Bank of India (RBI) advised banks to be cautious towards unsecured loans.

“Certain components of personal loans are recording very high growth. These are being closely monitored by the Reserve Bank for any signs of incipient stress,” said RBI Governor Shaktikanta Das while announcing the review of the monetary policy. Deputy Governor Swaminathan J pointed out that unsecured retail credit saw an “outlier” growth of 23 per cent in the past two years, compared to an overall credit growth of 12 to 14 per cent.

The genesis of this incessant rise of retail, as of many other situations facing us today, can be traced to measures necessitated by the Covid-19 pandemic. As businesses got disrupted, the RBI embarked on a quantitative easing mission while doing the tightrope walk between growth and inflation. It kept interest rates low, liquidity high, and put moratoriums on certain payments.

Taking advantage of the easier liquidity scenario, several companies reduced their debt levels, strengthening a trend that had started in 2015. At the same time, banks used the gains from the appreciation in the government securities portfolio, caused by the liquidity surge, to clean up their books.

The pricing (read interest rates) of top-tier loans rose because of the risks for banks. There was also an increase in bad loans. Naturally, banks became less open to pushing corporate loans at the same time when many kosher companies stopped looking for loans and the not-so-kosher ones became risky propositions.

Inevitably, retail loans zoomed.

“Over the past few years, banks had been focusing on retail, given the relatively weak demand for corporate loans. Given that both banks and NBFCs (non-banking financial companies) together are increasingly lending to the retail segment, my sense is the regulator is flagging concentration risks in the sector,” says Rohan Lakhaiyar, partner at Grant Thornton Bharat.

The RBI has pointed out that growth in per­so­nal loans accounted for 37.7 per cent of the incre­­mental credit in August 2023, on an annual basis. Credit card exposures grew at 30 per cent, auto loans at 21 per cent, and home loans at 14 per cent.

The retail loan party, however, might be running out of steam.

Herding behaviour

In its report, Trend and Progress of Banking in India (2021-2022), the banking regulator observed that in recent years banks appeared to have displayed a “herding behaviour” in diverting lending away from the industrial sector towards retail loans.

“Empirical evidence suggests that a build-up of concentration in retail loans may become a source of systemic risk. The Reserve Bank is equipped with its policy toolkit to handle any systemic risk that may arise,” said the report.

This is also seen in the Credit Market Indicator (CMI) of TransUnion CIBIL, which tracks the health of retail lending in the country. 

According to a report released in April this year, the CMI rose from 93 in December 2021 to 100 in December 2022. The report reveals that 35 million consumers bought their first credit product, that is, became “new-to-credit” in 2021. Another 31 million did so in the first nine months of 2022.

In 2021, the millennials, or those born between 1980 and 1994, accounted for the largest part of the new-to-credit population with a 42 per cent share. Gen Z, born 1995 and later, comprised 29 per cent. Of the new-to-credit consumers, 67 per cent were in rural and semi-urban areas in 2021.

As regulated entities expand the retail portfolio and tap the new-to-credit segment, more through unsecured loans and with less-than-ideal emphasis on credit histories, delinquencies could rise.

The RBI flagged the rising delinquencies in its Financial Stability Report of December 2021, observing that the new-to-credit segment was showing a dip in originations. It referred to the observation by the Bank for International Settlements that in emerging markets bad loans “typically peak six to eight quarters after the onset of a severe recession”.

Changing complexion

Over the past few months, the RBI has asked a few banks to submit their retail books with segment-wise break-up for the last five years. 
 

The break-ups show that some banks’ retail exposure had been growing at an annual rate of more than 60 per cent, with the share at the book level crossing the 50 per cent mark.

The RBI’s latest Financial Stability Report, of June this year, called attention to retail loan’s compound annual growth rate of 24.8 per cent between March 2021 and March 2023. That was nearly double the 13.8 per cent CAGR for gross advances during this period.

The composition of banks’ advances changed during this phase. The share of unsecured retail loans shot up from 22.9 per cent to 25.2 per cent and of secured loans fell proportionately, from 77.1 per cent to 74.8 per cent. Although the gross bad loan ratio in retail loans in the system was low, at 1.4 per cent in March 2023, the share of “special mention accounts” was relatively high at 7.4 per cent for banks — a 10th of the retail assets portfolio.

The RBI introduced the classification of special mention accounts in 2014 to identify accounts with the potential to become bad or stressed.
 

So, what is on the cards?

In May, Governor Das had conveyed to boards of banks that they should exercise prudence in growth strategies, product pricing and portfolio composition. Under-pricing or over-pricing of products, both on credit and deposit side, and concentration or lack of adequate diversification in deposit or credit profile could expose banks to higher risks and vulnerabilities.

“Let me emphatically state that the Reserve Bank does not interfere in commercial decision making of banks but only gives them a nudge to address potential risks and vulnerabilities,” he said.

There are times when nudges work as well as anything else. This could be one of those times.