Banking Central | What does RBI know about unsecured loans that we don't?

RBI Governor Shaktikanta Das warned banks on growth in unsecured loans

A sharp spike in certain categories of loans seems to have become a cause for concern for the central bank as was evident in the words of Reserve Bank of India Governor Shaktikanta Das in the post-policy press meet last week. His obvious reference to unsecured retail loans is significant and timely.

A recent Banking Central column too had highlighted the menace in the making.

Although the governor assured that there was no immediate cause for alarm, the central bank has sensed a potential danger in such credits. The trigger for the RBI was a sharp growth in loans that are traditionally deemed high-risk as lenders went on an aggressive overdrive to boost their personal loans kitty. RBI Deputy Governor J Swaminathan said that in the last two years, unsecured retail credit has spiked 23 percent as against an overall credit growth of 12-14 percent in the system, making it an "outlier" segment. The central bank’s caution has perhaps come in this backdrop.

A run down through through some numbers from the RBI prove the reason behind the worry. Credit to the segment surged 30.8 percent by end-August this fiscal, as against 19.4 percent recorded in the comparable period last year. Credit card loans have outpaced others with an over 30 percent jump from 26.8 percent a year back, while education loans grew 20.2 percent from 11 percent last year, the latest RBI data shows.

But, what’s wrong with personal loans? Wherever these loans are unsecured (not backed by a collateral), there is a higher risk of default involved for banks in the event of an economic slowdown or, to put it simply, when things go bad. Although Das said the RBI is warning banks only to sensitise them and asserted that there is no problem at present, earlier cycles  show that the central bank doesn’t issue warnings on specific segments unless it identifies a problematic trend. So, it is safe to assume that the RBI is not comfortable with such high growth in unsecured loans.

In the earlier bad loan cycles, Indian banks have seen a sharp rise in unsecured loans during economic downturns when job losses and income losses hit the borrowers. In its Financial Stability Report released on June 28, the RBI had said that 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.

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.

Does the regulator know something about the growth in unsecured loans that we don’t? Well, let's wait and watch.

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