Banks could prescribe debt-to-income ratio for healthy retail loan book: Study

Policy researchers are suggesting an additional parameter – individuals’ debt to income (DTI) – to judge a borrower’s credit- worthiness while extending retail loans to avoid any adverse impact at the system level. “DTI limits along with restrictions on loan-to-value (LTV) ratios are found to be effective macro prudential tools that can be synchronized to contain systemic risks” , said RBI economists in a research paper.

The retail credit growth is led by a well-diversified customer base, with reasonably good financial health conditions barring a few pockets of incipient weakness, pointed a study by Reserve Bank economists. The trends as depicted in the study underscore that it is imperative for banks and other financial service providers to monitor the retail segment closely and continuously for any undue build-up of stress, notes the study.

The problem of sustainability of the current surge in retail credit flows hinges on the health of two broad sectors of the economy-households and financial service providers- banks and non-bank financial corporations, it said.

The study concludes saying that policymakers may also consider using structural prudential tools like debt-service ratio and debt-to income ratio of retail borrowers. While macro prudential tools like specifying differential risk weights for various classes of retail products reflecting their inherent riskiness impart lender resilience, encouraging the use of emerging technology ecosystems like account aggregators, to seek requisite consent from the borrowers, strengthen credit underwriting; and strengthen monitoring of models.

This can be further extended by prescribing debt-to income (DTI) limits for certain borrower or product categories. DTI limits along with restrictions on loan-to-value (LTV) ratios are found to be effective macro prudential tools that can be synchronized to contain systemic risks. Also, such macro prudential tools can be quickly calibrated in line with the evolving macro-economic situations to support or dampen the credit growth according to the paper titled ” Dynamics of Credit Growth in the Retail Segment: Risk and Stability Concerns” by Vijay Singh Shekhawat, Avdhesh Kumar Shukla, ACV Subrahmanyam and Jugnu Ansari published in the latest monthly Bulletin. The views expressed are those of the authors and do not reflect or represent that of the Reserve Bank.

The study also finds that the quality of retail loan portfolio continues to be healthy across the banks, product categories and borrower risk classes, despite a surge in growth. However, it also finds that a few subcategories in the unsecured retail sector show signs of weakness, which need to be closely monitored by lenders.