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Why RBI is making it tough for you to get a personal loan

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Unsecured tiny personal loans, mostly below Rs 10,000, have been selling like hot cakes as overzealous banks pushed them hard. While it meant brisk business for banks, they also came with risk. After warning the banks, the Reserve Bank of India (RBI) has now slammed the brakes on the unbridled growth in consumer loans that lately expanded faster than less risky lending assets, directing banks to set aside more capital and establish board-monitored processes on such loans to prevent risk escalation in the financial system.

The RBI on Thursday increased risk weights on these loans from banks, non-banking finance companies (NBFCs) and credit card providers. This means it will now be more expensive for lenders to offer such loans to consumers and thus you will have to pay higher interest on these loans. However, the new rules are not applicable to housing loans, education loans, vehicle loans and loans secured by gold and gold jewellery, the RBI said.

RBI Governor Shaktikanta Das, in his monetary policy statement last month, had asked banks to pay more attention to the unsecured lending segment, flagging the risks to financial stability.

Where is the risk?

Isn’t it good that more people are getting small loans which boost consumption and in many cases are even used as investment in small businesses? But being unsecured, even though small, they can escalate risk in the system if they grow excessively. The RBI found that credit growth in unsecured loans has been an outlier at about 23 per cent as compared with an average of 12-14 percent of credit growth in the country. It has even outpaced the overall bank credit growth of about 15 per cent seen over the last year.

Small ticket borrowers are slowly starting to miss their repayments and seen to be delaying repayments beyond a month of the scheduled date. For consumers having at least one small-ticket personal loan, the balance-level delinquency rate or the percentage of borrowers missing a repayment was 5.4% in Q2’ 2003-24 , up 120 bps (basis points) since Q2 2022-23 a report by credit bureau Transunion Cibil notes.During Q2’ 2023, overall balance-level serious delinquencies (measured as 90 days or more past due) improved across product categories, except for credit cards and personal loans according to the report.But delinquencies on small-ticket personal loans have a marginal impact on the overall retail loan portfolio, which looks at the outstanding balances of all retail products including home loans, auto loans, credit cards, personal loans, and others. Small-ticket personal loans of less than Rs 50,000 account for 0.3% of the total retail loan book size at an industry level. Even though delinquencies on small-ticket personal loans have a marginal impact on the personal loan portfolio, these need to be monitored closely, especially because consumers may prioritize other payment obligations ahead of personal loan payments, which in turn may be a wider indicator of financial stress, the credit bureau report said.

The credit industry landscape has changed significantly over the last four years. Since January 2022, small-ticket personal loans of less than Rs 50,000, while representing a very small share of total retail balances, have accounted for approximately 25% of total origination volumes. As a result, the proportion of credit active consumers availing small-ticket personal loans has increased to 8% in June 2023, from 3% in June 2019.

“The marked increase in the volume of consumption loans along with velocity indicates a clear call for lenders to monitor vintage delinquencies closely. Strong underwriting process, focused regular monitoring of consumer behavior, and robust credit risk management practices are essential if these opportunities are to be nurtured for long-term profitable growth,” said Rajesh Kumar, MD and CEO of TransUnion Cibil.

What the banks say

After RBI Governor Das’ warning last month, the finance ministry asked state-run banks to review their small-loan portfolios and submit a report detailing the situation. Banks said the number of these loans may be large but the ticket sizes are not high, ET reported recently, based on information from sources. “Almost all PSBs (public sector banks) have stated that in this segment there has been no spike in delinquencies and most borrowers have credit scores of 700 and above,” an official told ET, underscoring the stable asset quality of these loan accounts.

However, the official told ET that certain components of personal loans are recording very high growth, adding that these were being closely monitored by the RBI for any sign of stress.

A recent report by Swiss investment bank UBS said public sector banks are likely to have higher defaults than their private counterparts, as credit losses from unsecured retail loans could increase 50-200 basis points in 2024-25. A basis point is a hundredth of a percentage point. “State-owned banks likely had 52% of their outstanding personal loans to borrowers with credit scores below 644 (medium to high-risk borrowers), while NBFCs had 49% and large private banks about 31% in June 2023,” the UBS report said. Bankers maintain that their exposure is limited.

Most bankers are unwilling to concede there is any risk building up and say that the delinquencies are well within limits.

“I have said it in the past and still maintain that our unsecured book is better than the secured book,” SBI chairman Dinesh Khara told reporters after the bank announced its results early this month. He added that the bank did not extend loans below Rs 50,000. In response to analysts’ questions, Khara said that RBI has been in talks with banks on these issues, and that SBI’s interpretation is that the central bank is more concerned about the small loans extended to new-to-bank borrowers.

Bank of Baroda MD & CEO Debadatta Chand has said recently that his bank’s unsecured loan portfolio is sound with low non-performing assets, and all the borrowers are existing customers. He said that new customers are extended unsecured personal loans only if they join with a salary account.

“More than 85% of our loans are to salaried customers who have stable jobs in MNCs, PSUs or large corporates. Our current trends in delinquencies are all under identified risk levels according to our own and Cibil credit scores. What we are seeing is the risk building in the Rs 50,000 and below ticket size where the bank does not have any meaningful exposure,” Sandeep Batra, executive director at ICICI Bank, said last month.

UBS expects the banking industry’s credit losses from unsecured loans to rise between half a percentage point and 2 percentage points in fiscal 2025. “The share of borrowers with more than five personal loans (PL) rose from 1% in 2018 to 7.7% in March 2023. Additionally, new PL disbursement to borrowers with weaker credit profiles exposes this segment to a potential downcycle, in our view. NBFCs and state-owned banks have a higher share of weak PL borrowers than large private banks,” UBS said.

The report said unsecured loans as a percentage of total loans rose to 11.1% for SBI and 10.7% for Axis Bank. “We believe the probability of regulators increasing the risk weight for PL is rising, and a 25% hike could lead to a 740-basis-point (7.4 percentage point) drop in CET-1 ratios of banks we cover,” the report said.

The report said the share of unsecured loans (PL and credit card) in total retail loans has more than doubled in the past five years, rising from 4% to 8.2%. The share of private sector banks in PL outstanding fell from 41% in FY20 to about 35% in FY23, the report said.

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