Banking Central | Will the rise in unsecured retail loans backfire on banks?

NPA

Unsecured retail loans are making a comeback. Going by the latest Financial Stability Report (FSB) of the Reserve Bank of India (RBI), the composition of secured and unsecured advances has changed between March 2021 and March 2023. This period saw unsecured retail loans rise from 22.9 percent to 25.2 percent and secured loans fall from 77.1 percent to 74.8 percent. This means that banks are clearly eying to grow their unsecured book that include credit card loans, personal loans, and so on.

Some stress in this segment is already visible. Although the Gross Non-performing assets ratio of retail loans at the system level was low at 1.4 percent in March 2023, the share of special mention accounts (SMA) was relatively high at 7.4 percent for SCBs and it accounted for a tenth of the retail assets portfolio of PSBs. Special mention accounts or SMA are those where payments are due but still below the 90-days mark, hence not an NPA yet. To be classified as an NPA, payments should be overdue for 90 days.

Yet, the RBI report seems to be assuring that the situation isn’t worrying at this stage. The report cites two reasons. One, the share of doubtful retail loans in SMA category has fallen from 4.2 percent in March 2021 to 2.3 percent in March 2023. Second, unsecured retail loans formed only 7.9 percent of the total banking system credit as at end March 2023. Moreover, the overall asset quality has improved, with the GNPA ratio declining from 3.2 percent to 2.0 percent during this period.

"Thus, notwithstanding few signs of potential stress in retail loans, they do not pose an imminent risk to systemic stability,” the RBI report says.

However, there is a subtle caution that one can't miss. Clearly, the message to banks is that they must be watchful against the growth in unsecured retail loans. There are early signs of stress evident in the credit card portfolio where the NPAs for public sector banks rose to 18 percent as on March 2023 compared with 9 percent a year ago.

Unsecured loans are risky loans because they don’t have any collateral against the loaned amount. This means in the event of an economic downturn, typically characterised by job-losses and income decline, banks will likely feel the heat from this segment early as the ability of the borrowers to pay back will suffer. When that happens, banks won’t have anything to rely on. There is no collateral to recover.

The present global economic situation remains uncertain with fears of a recession still looming in global markets. Also, if the interest rates remain too high for too long, it can reverse the gains of a nascent economic recovery in countries like India. Banks have had their share of pain in the past due to careless lending in the aftermath of 2008 global financial crisis. It took half a decade after that to clean up the books following an asset quality review by the central bank in 2015. Banks shouldn't repeat the mistake of being reckless again on risky loans.

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