If the Reserve Bank of India’s (RBI) actions and words in the last week are anything to go by, it is gravely concerned over the rise of unsecured small-ticket loans in the country. In an effort to prevent a credit crisis, the Reserve Bank of India (RBI) has banned loan products like 'eCOM' and 'Insta EMI Card' and increased the risk weightage on personal loans from 100% to 125%.
This will make it harder for banks and other financial institutions to lend. Vivek Iyer, partner and national leader for financial services risk at Grant Thornton, told The Core, “They (the RBI) are right in the sense that it is a substantial rise. And there needs to be a focus from a portfolio quality standpoint, whether increasing the risk rate is an answer or not.”
Concerns About Growth
Higher cost of credit impacts India’s growth potential. At a time when the cost of credit is increasing globally, Iyer said that an analysis of the overall credit portfolio would better address the problem of the rise in unsecured credit. “The underlying problem that exists is definitely something that needs to be corrected. And I feel that a supervisory oversight on that portfolio combined with tighter and stronger credit underwriting standards, as well as portfolio monitoring is something that the industry should do,” Iyer said.
The RBI has been flagging the rise of unsecured personal loans, particularly in the sub-Rs 50,000 category. Loans overall have become expensive. The RBI has opted for rate hikes and interest rates have gone up in the last 18 months, making borrowing an expensive affair for existing borrowers. Since FY23, the RBI opted for a cumulative rate hike of 250 bps. Larger macroeconomic stress also means that new borrowers are few and far between. Unsecured loans for consumer spending are making up for negligible loan growth on the corporate side.
While rising consumerism isn’t a problem and could boost growth, a lifestyle funded on debt, which has become the new normal, is one. Thanks to the easy access to small-ticket loans provided by fintech companies on their platforms a lot of young people, earning under five lakhs per annum, for example, are availing products like buy now, pay later to fund consumption.
While the ticket size of the loans disbursed by fintech companies may be small, there is a sizable population that avails of these loans. A recent report by Equifax showed that the highest number of personal loans have been disbursed in the less-than-Rs 5,000 category. The Rs 5,000-10,000 loan category witnessed the highest growth of 493% in the April-September 2022 period compared to the same period a year ago. To address the demand side, the overall credit portfolio needs to focus on having a healthy balance between credit for consumption and credit for investment.
“Dwelling, consumption, and not focusing on investment, is definitely a problem. In terms of the whole idea of unsecured lending, the ecosystem needs to align to have a good balance between investment-related lending and lending from a consumption standpoint. Not to say that consumption-driven lending shouldn't be there. But if you were to literally break down the portfolio, there is an unwanted focus on consumption,” Iyer said.
Role Of Fintech Companies
Iyer said that to reduce consumption-related lending, it is important for institutions to analyse their own portfolio and see what kind of exposure they are choosing and what kinds of tests they are running to ascertain the feasibility. “The problem is that most of the stress test framework uses variables that they've experienced in the past. There are global uncertainties about what the impact will be as a result, if the war persists. I think that's the bigger concern.”
The focus now shifts to the business model of fintech companies that offer unsecured loans to consumers. These companies primarily started off on the promise of bringing digital innovation that was supposed to help banks provide larger digital inclusion. However, in due course, they gradually deviated and got into lending business, once they failed to be profitable through innovation alone. However, fintech companies are still relevant because they are the ones that would be getting more customers into the ecosystem.
“It is the balance sheets that have leveraged where they actually need to take a more balanced look. So probably they need to start cutting the exposures. The moment the limits that are available to fintechs are reduced, automatically, the ecosystem will be controlled. Expecting the fintechs to do less, may not necessarily be the answer,” Iyer said.