A prudential approach to risk management must not hold back credit availability for the needy

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In November, the Reserve Bank of India (RBI) raised the risk weights that lenders apply to unsecured retail loans and bank loans to non-banking financial institutions (NBFCs). The objective was to check the rapid growth in unsecured lending in recent years. These are loans that are not backed by collateral. Hence, in case of a repayment default, the lender must bear the full loss. Higher risk weights translate into lenders needing more funds to maintain their capital adequacy ratios so that defaults can be absorbed with less impact on their balance sheets. However, higher risk weights lower banks’ net returns on such loans. In turn, banks tend to lower lending in such segments or charge higher interest rates.

Retail loans by scheduled commercial banks grew at a compounded annual growth rate (CAGR) of 17% for the 5 years ended 31 March 2023. Non-retail loans grew at a CAGR of 7% in this period, while retail loans by NBFCs have grown at a CAGR of 26% for the 5 years ended 31 March 2022. Lenders, especially banks, pivoted to retail lending after witnessing poor asset quality in corporate, agricultural and MSME lending. The share of retail loans in outstanding bank credit increased to over 30% in 2023 from about 20% in 2018. The NBFC lending trend is along similar lines.

Retail loans can be broadly classified into those taken for asset purchases (i.e., for a house, consumer durable, education, etc) and for consumption or events (holidays, wedding celebrations, etc). RBI has expressed concerns over the quality of unsecured retail advances as bank assets. These include consumer-durable loans, credit-card spends, open-ended personal loans, et al. According to industry sources, the risk of quality deterioration (i.e. of loans not repaid) is concentrated in small-ticket personal unsecured loans (of under 50,000).

Unsecured personal loans, however, are not necessarily unproductive. Consider consumer durable loans. Most improve the quality of life of loan-bearers and potentially increase the earning capacity of relatively low-income households that do not have sufficient savings to buy such products with upfront lump sums. For example, smartphones have enabled gig workers to earn respectable livelihoods. The accessibility of easy financing options (no-cost EMIs and other buy-now-pay-later schemes) has made smartphones and other consumer durables more attainable for low-income households.

If RBI’s directive reduces the availability of such loans to these households, it may hinder India’s overall economic demand and recovery. It’s important to note that an increase in lending rates, a likely consequence of elevated risk weights, may not deter wilful defaulters who are typically undeterred by higher interest charges. However, genuine demand for and the availability of small-ticket consumer loans, crucial for the well-being of lower-income groups, might be adversely affected. Lenders therefore need to be cognizant of the intent behind RBI’s directive.

Retails loans are just a call or tap away nowadays and disbursal is almost instant. Hardly any of us has escaped recurrent phone calls offering personal loans and “lifetime free” credit cards. Technology has sharply brought down the delivery cost of small-ticket loans. This has helped formal lenders reach nearly every pin code in the country. PayTM recently said that as of 30 November, over 70% of its unsecured loans were under 50,000. The latest data from CRIF High Mark, a credit information company, shows that over 85% of personal loans in fiscal year 2021-22 were under 1 lakh, compared to just 35.3% in 2017-18. The number of credit cards in India has grown at a CAGR of 17%, while the amount outstanding on these cards has grown at a CAGR of 24% for the 5 years ended 31 October 2023.

Many new-age lenders and fintech firms pride themselves in having proprietary models and relying on alternative data to assess the credit risk while giving out loans to customers. Lenders must fine-tune their models to determine risks and willingness to repay. They need to identify genuine customers for credit. While increasing the reach of formal credit is necessary, robust mechanisms must be implemented while dealing with new-to-credit customers. It is a challenge to estimate any borrower’s intent to repay. Credit scores are one such tool to assess a borrower’s creditworthiness with some credit history. However, the credibility of credit bureaus has become questionable after RBI imposed fines on them for not maintaining accurate borrower data.

While there is a valid need for improved risk assessment before granting loans, industry practices that play on the cognitive biases of consumers, such as claims of zero-cost EMIs, cash-backs, instant discounts on EMIs, etc, must be curtailed and regulated. Such advertisements play on the aspirations of people and promote impulse-buying behaviour. Attention must also be given to identifying wilful defaulters and enhancing loan-repayment collections from them.

A prudent approach to risk management is essential. It is equally imperative to safeguard the availability of credit for vulnerable sections of society. Lenders may become too risk averse in the light of recent RBI actions and earnest low-income borrowers could suffer. Balancing these considerations will be pivotal in stabilizing the financial system and fostering a more inclusive and sustainable economic growth trajectory.

These are the authors’ personal views.



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