Repayment stress

Early warning signs from retail loans

The Financial Stability Report (FSR), released by the Reserve Bank of India (RBI) last week, made it clear that the financial system was broadly resilient, and scheduled commercial banks in particular had emerged from the stresses of the pandemic reasonably well and were capable of performing their functions. The period of the pandemic featured several emergency measures that supported the purchasing power of the population and the lending ability of banks. These measures have now largely been withdrawn. They could have, as they were withdrawn, left the banks with a large proportion of bad debts. However, this does not seem to have been the case. In March 2023, the ratio of gross non-performing assets (NPAs) was at a decade’s low of 3.9 per cent, and the FSR indicated the central bank expected this ratio to fall further to 3.6 per cent over the course of the current financial year under the baseline scenario.

There are specific areas, however, where some early warning signals might be detected. One of these is in the area of retail loans. The broad trend over the past decade has been for both an increased supply and increased demand for such loans. Consumer demand for unsecured loans from scheduled commercial banks has only increased with the collapse of the non-banking financial sector in the years immediately preceding the pandemic. Many banks have also decided to make retail lending a larger proportion of their loan book, and this switch was enabled by supportive regulatory policy, which modified the risk weightings of unsecured retail loans. Overall these loans have not begun to turn bad. The gross NPA ratio for retail loans was only 1.4 per cent in March 2023. But the FSR has pointed out that other, more sensitive categories — such as the proportion of retail loans delinquent with their payments for more than 30 days but less than 60, or more than 60 days but less than 90 — have increased.

Should this be considered an early warning of some stress in this sector? The FSR points out that increases in inflation would cut into real income; and if that is accompanied by increases in interest rates, then the ability to repay for many retail borrowers would be reduced. It is possible therefore that the proportion of retail NPAs would increase in a higher-inflation, higher-rate environment. Given the growth of the unsecured retail loan books within the banking sector, this might pose an overall problem. However, the FSR is very clear that the central bank does not yet see this as a threat to financial stability. Observers will also note that there is much more data available to judge the creditworthiness of borrowers today than there was a decade or so ago, and thus banks might be doing a better job of identifying safer unsecured loans than earlier. Certainly, the stock of such loans has not exploded, as it would have if banks were being obviously irresponsible. Thus, the banking regulator and banks themselves will have to stay watchful but need not be concerned just yet. Broader observers of the Indian economy, however, should indeed be a little more concerned about the repayment delays, and what they may indicate about the stresses that retail borrowers are facing.