Unsecured retail loans, despite necessitating revised lending practices, can be productive. Access to smartphones is emblematic of the impact of convenient financing options.
The Reserve Bank of India (RBI) implemented a strategic measure in November by increasing the risk weights for unsecured retail loans and bank loans to non-banking financial institutions (NBFCs). This move aimed to address the escalating growth of unsecured lending, which poses a potential risk to lenders in the event of repayment defaults. The elevated risk weights necessitate a higher capital adequacy ratio for lenders, thereby impacting their net returns on unsecured loans. Consequently, this prompts banks to reconsider their lending in these segments or adjust interest rates accordingly.
Scheduled commercial banks witnessed a substantial 17% growth in retail loans over the last five years, contrasting the 7% growth in non-retail loans. Concurrently, retail loans by NBFCs exhibited a remarkable 26% growth over the same period. Banks notably shifted focus to retail lending following challenges in corporate, agricultural, and MSME lending, resulting in an increased share of retail loans in outstanding bank credit.
RBI expressed apprehensions regarding the quality of unsecured retail advances, particularly in segments such as consumer-durable loans, credit-card expenditures, and open-ended personal loans. The inherent risk of quality deterioration is notably concentrated in small-ticket personal unsecured loans (of under ₹50,000), prompting vigilance and regulatory actions.
Unsecured personal loans have been crucial in driving economic empowerment and improving the quality of life for many individuals in India. Let’s take a closer look at the potential impact of RBI’s recent directive on consumer durable loans and the availability of small-ticket consumer loans.
Consumer Durable Loans and Economic Demand
The provision of consumer durable loans has been instrumental in enhancing the earning capacity of low-income households. This easy access to financing options has made essential products like smartphones more attainable for individuals with limited savings, enabling them to participate in the modern economy and earn respectable livelihoods. The reduction in the availability of such loans may have adverse effects on India’s overall economic demand and hinder the country’s recovery.
The Risk of Elevated Lending Rates
While an increase in lending rates, resulting from elevated risk weights, may not deter wilful defaulters, it could significantly impact the availability of small-ticket consumer loans. Genuine demand for these loans, crucial for the well-being of lower-income groups, may be adversely affected, highlighting the need for lenders to understand the intent behind RBI’s directive.
The Accessibility of Small-Ticket Loans
Technological advancements have significantly reduced the delivery cost of small-ticket loans, enabling formal lenders to reach a broader segment of the population. The convenience and instant disbursal of retail loans have made them more accessible than ever before, with a substantial portion being under ₹50,000. The rise in the number of credit cards and the outstanding amount on these cards reflects the growing reliance on unsecured credit in India.
Balancing Risk and Inclusion in Lending Practices
With the emergence of new-age lenders and fintech firms, the use of alternative data for credit risk assessment has become prevalent. However, a careful evaluation and fine-tuning of credit models are crucial to identify creditworthy customers. While widening the scope of formal credit is essential, special attention is warranted for new-to-credit customers to ensure responsible lending. The reliability of credit scores is pivotal, but the recent penalties imposed by the RBI on credit bureaus have raised concerns about the accuracy of borrower data.
Addressing the need for enhanced risk assessment, it is imperative to regulate marketing tactics that exploit consumer biases, such as enticing offers and promotions. Moreover, identifying and managing wilful defaulters is a pressing concern that demands due attention.
Balancing risk management with the accessibility of credit for marginalized segments is vital. The recent regulatory actions by the RBI may lead to excessive risk aversion among lenders, potentially affecting low-income borrowers. Striking a balance between prudence and inclusivity is crucial for the stability and sustainable growth of the financial landscape.
These are the authors’ personal views.
