The impact of this decision will potentially be on loan seekers and it is likely that the low-ticket loans may not be so readily available as banks will be required to maintain a higher CRAR or capital to risk-weighted assets ratio.
The Reserve Bank of India’s (RBI) decision to increase risk weights on consumer credit does not come as a surprise as the banking regulator finds the risks around unsecured loans to be potentially problematic and the situation may not be as hunky-dory as is being made out by banks and non-banking financial companies.
In his October monetary policy speech, the RBI Governor Mr. Shaktikanta Das touched upon the issue commenting that certain components of personal loans were recording very high growth and the banking watchdog was closely monitoring signs of incipient stress. The warning to banks and financial institutions came in the wake of rapidly changing global financial landscape and the RBI said that potential stress could come from unanticipated corners.
The Governor advised the banks and NBFCs to strengthen their internal surveillance mechanisms and address the build-up of risks.
The government sprang into action without taking much time with the Union Ministry of Finance asking the public sector banks to review their low-ticket loan portfolios and also submit a report explaining the situation.
The Story So far
The current rules prescribe a 100 per cent risk weights to consumer credit of commercial banks and NBFCs, which upon RBI’s review, was increased by 25 per cent to 125 per cent for all outstanding as well as new loans including personal loans. Meanwhile, housing loans, education loans, vehicle loans and loans secured by gold and gold jewellery have been kept out of the purview of the November 16 notification.
One of the mainstays of consumer spending, credit cards, have also come under the ambit of the RBI notification. The current rules put a risk weight of 125 per cent on credit card receivables of scheduled commercial banks while a risk weight of 100 on credit card receivables of NBFCs. This has been raised by 25 per cent taking the risk weights to 150 per cent for SCBs and 125 per cent for NBFCs.
The notification has also withdrawn priority sector lending status for loans to housing finance companies (HFCs) and NBFCs.
Unsecured personal loans with ticket size as low as Rs. 10,000 were being disbursed by the banks and NBFCs unrestricted, putting them at great risk. The banks and NBFCs have been pushing these loans among the consumers to tap a larger pool in the credit space by enticing them with the offer of collateral free loans. That has led to increased consumption over the months.
Especially at the time of festivals, these small ticket loans help consumers pressed with financial needs to spend with a thought that they would pay it later. As per the findings of the RBI, credit growth in unsecured loans jumped about 23-25 per cent compared with an average of 12-14 per cent of credit growth in the country. The traction for unsecured loans outpaced the overall bank credit growth of about 15 per cent on the year-on-year basis.
One media report pointed out that small-ticket personal loans of less than Rs 50,000 have accounted for 25 per cent of the total loan volume raising the proportion of credit active consumers availing small-ticket personal loans to 8 per cent in June 2023 from 3 per cent in June 2019.
The stress level could be catastrophic for the Indian banking system if the defaults start increasing as the low ticket loan will be sought primarily by those who have low liquidity levels.
One data set suggests that the percentage of borrowers missing repayments in the July-September quarter of the current financial year is above 5 per cent which has gone up by 120 basis points reported in the corresponding quarter of the last financial year. This was for customers who had at least one small-ticket personal loan.
For public sector banks, the situation is more significant than their private peers as is said by UBS which is a Switzerland-based investment bank. It has estimated higher defaults for PSU banks. According to a report by UBS, credit losses from unsecured retail loans could spike by 50-200 basis points in FY2024-25. The report said that 52 per cent of outstanding personal loans of state-run banks were given to those consumers who have credit scores less than 644. For NBFCs, it is 49 per cent and for large private banks it was about 31 per cent in June 2023.
The report also finds that consumers with more than five personal loans rising to 7.7 per cent in March 2023 from 1 per cent in 2018.
The Reserve Bank’s action may be seen as a rap on the knuckles of the banks and a timely alter to set their houses in order. The banks need to scrutinise their loan offers by setting up robust check mechanisms.
The impact of this decision will potentially be on loan-seekers and it is likely that the low-ticket loans may not be so readily available as banks will be required to maintain a higher CRAR or capital to risk-weighted assets ratio. This will also increase borrowings of the bank to maintain their capital requirements. The banks will be paying to recapitalise them and hence will likely charge more from the consumers.
An Indian Express report said that following the RBI decision to increase the risk weights, the banking industry will likely require Rs 84,000 crore of excess capital which translates into 5 per cent increase over the Rs 15.2 lakh crore capital requirement.
What the banks say?
The banks’ stance have been rather defensive on this issue with many of them coming out to clear their positions. While they have acknowledged that the loan numbers for small amounts may be high, the delinquencies have not spiked, they say. The banks have also said that most borrowers have credit scores of 700 and above.
They also said that small ticket loans form a small portion of the overall retail loan book of the banks. These loans are also not a very significant part of the personal loan segment.
The RBI warning is a welcome step and appears timely as a stitch in time saves nine. The Indian banking regulator has always been more proactive in warning systemic risks unlike central banks of even major economies like the US where we saw a systematic upsetting in the banking sector early this year.