Banking Central | Unsecured loans are rising fast and that's not good for banks

Credit card outstanding across banks have gone up significantly in the past year

Are Indians borrowing to live it up? In recent months, there has been a significant jump in the retail book of banks, particularly credit cards and other personal loans. In the 12 months ending May 31, credit card outstanding has grown by close to 30 percent, almost at the same pace as the preceding 12 months. The overall industry loan growth has been 15.6 percent. It’s not just credit card spending, other personal loans, too, have grown around 23 percent from the previous year.

Why its a worry

What's so special about these numbers? These are unsecured loans — banks do not have collateral against them. In the event of a credit failure, lenders will be sitting ducks, not a healthy scenario for an industry that has just about managed to get its books in order.

Some early signs of stress are already visible. While announcing the April-June quarter earnings, private lender Kotak Mahindra Bank said its chunk of unsecured retail loans as a percentage of the total book grew close to 11 percent from 7.9 percent in the year-ago quarter. Retail microfinance loans surged 91 percent over the year-ago quarter and credit card outstanding jumped 67 percent.

Retail microloans are extended to low-income groups which are typically small businessmen and vendors. These loans are tricky as cash flows typically take a hit during a down cycle. The trend is in line with the industry where banks are stepping up lending to unsecured loans post Covid.

Banking Central

In a post-earnings interaction with the media, chief financial officer Jaimin Bhatt said Kotak Mahindra Bank witnessed slippages from segments such as tractor finance and unsecured retail loans in the first quarter of the current financial year.

A slippage is when there is no repayment of interest or principal for 90 days, making the loan a non-performing asset (NPA). Banks need to set aside money in the form of provisions to cover such loans. Higher provisions impact the profitability of a lender.

And it is not just Kotak Mahindra Bank. ICICI Bank, which came out with its numbers the same day, has seen the personal loan book grow almost 39 percent in the June quarter from the year-ago period.

Credit cards outstanding has grown at 45.4 percent. Personal loans now contribute to around 16.3 percent of the book and credit cards 7 percent. That is a sizeable chunk.

Telling signs of stress?

The trend is largely similar to other private banks. For IndusInd Bank, credit card outstanding has grown 39 percent on a year-on-year basis.

Why do these numbers matter?

Trends in bank loan disbursements and recovery often offer vital clues to the state of the economy. During an economic downturn, typically unsecured retail loans and loans given to small and medium enterprises take a hit first. That’s because the financial capacity of the borrowers is weak compared with large corporations.

The emerging stress in unsecured loans could be an indication that not all is well on the ground. Of course, one needs to wait and watch for numbers from other banks to get a clear picture over the next few quarters.

RBI is watching

The Reserve Bank of India is worried about the rising bank exposure to unsecured loans. The regulator has already taken note of the jump in the retail loan book of banks.

In its Financial Stability Report released on June 28, the RBI said the share of large borrowers in gross advances of banks declined successively over the past three years, as retail loans grew faster than borrowings by corporates. The share of big borrowers declined from 51.1 percent in March 2020 to 46.4 percent in March 2023.

The RBI has already cautioned banks about the rise in unsecured loans, citing bank crises elsewhere in the world.

In informal interactions with bank chiefs, the regulator conveyed the need to limit the growth in unsecured books, so that the banks can handle the shock in the event of a financial meltdown. Banks will do well to pay attention to the regulator.

(Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.)