India's shadow lenders retreat as bad loans increase amid crackdown

Six years after the country’s shadow-banking sector blew up, pockets of stress are building again, prompting firms to start pulling back amid scrutiny from the Reserve Bank of India (RBI).  

Bajaj Finance, India’s largest non-banking financial company (NBFC), joined rivals including Shriram Finance, Mahindra & Mahindra Financial Services, and IIFL Finance that posted higher delinquencies on unsecured loans in their second quarter earnings reports. Most firms also set aside more capital for provisions and had lower profits than expected.  

The “Goldilocks” moment for lenders riding the wave of demand for loans from retail customers while maintaining clean balance sheets may have clouded. These firms are grappling with an increase in bad loans, margin compression and intense competition for deposits, according to bankers and analysts.  

 

RBI Governor Shaktikanta Das said last month that even though the overall sector remains healthy, there are outliers who pursue an “imprudent, growth-at-any-cost approach,” which is counter productive. A week later, the central bank stopped new loans at four shadow banks.   

NBFCs accounted for 15 per cent of assets in the financial system as of March 2023, according to the RBI. While these lenders boost profits through higher interest rates on loans, they’re more vulnerable to defaults when the economic cycle turns, according to Moody’s Ratings. 

Even though they are a small part of overall lending, the signs of stress are prompting firms to pull back on personal loans, a move that may impact growth. Shadow lenders’ asset growth will slow to between 16 per cent to 18 per cent in 2024-25, down from 25 per cent in the previous financial year, according to rating agency Icra.  

Bajaj Finance, one of the largest unsecured lenders, is cutting the number of clients with multiple loans, according to a presentation.  

Axis Bank is also slowing disbursements on unsecured products. “There is no acceleration in that business that’s happening at this point,” said Subrat Mohanty, executive director, banking operations & transformation at Axis Bank, referring to personal loans.  

The surge in bad loans on credit card, personal loan and microfinance portfolios comes nearly a year after the banking regulator tightened rules for unsecured loans, trying to get ahead of any blow-ups.  

RBI last year asked NBFCs and banks to increase buffers for some consumer loans in an effort to check the “exuberance” in unsecured loan growth. It also mandated banks to increase their risk weightings to the non-bank sector. 

 

“Without Reserve Bank of India’s action last November, the current situation could have been worse,” said Amod Khanorkar, chief rating officer at Infomerics Ratings. 

“Individual borrowers have taken personal loans to consume things they cannot afford due to limited incomes,” said Nirmal Jain, founder of IIFL Group, a financial services conglomerate, whose loan losses and provisions rose by 62 per cent in the September quarter from the previous three-month period. “This has triggered defaults in those loans.” 

Shadow lenders, including Bajaj Finance and Piramal Enterprises, pointed to over-leveraged borrowers for the rise in non-performing assets, and said they were tightening underwriting norms. Bajaj Finance’s soured loans expanded to 1.06 per cent in the September quarter, up from 0.91 per cent the prior year. 

“The only way out here is to reduce the exposure,” wrote Suresh Ganapathy, head of financial services research at Macquarie Capital, in a note.  

Already, credit growth has moderated sharply to 12.8 per cent year-on-year as of October 25, from 19.3 per cent a year earlier, according to RBI. All consumption-led products like credit cards, consumer durable loans and personal loans are experiencing a tightening of capital, according to TransUnion CIBIL.  

Firms have to improve their underwriting standards to stem the rise of bad loans on their books, Khanorkar said, adding that shadow lenders and fintechs will bear the brunt of increased defaults and credit costs.  

“Going forward, non-banks will go slow in unsecured personal loans amid cautionary signals,” said IIFL’s Jain.