Vault Matters | Why lenders need to be blamed for the ‘overleveraging’ mess

With a host of fintech lenders waiting to entice the urban middle class with small-ticket loans it is only natural that indebtedness is bound to increase.

The corridor buzz in almost every bank in recent weeks has been about a complaint received by the Reserve Bank of India from a customer who claims that he is being severely harassed by banks to repay his loans. The fun part starts here. His complaint mentions that he has taken thirty loans from various banks and, unfortunately, his income doesn’t permit him to repay more than two or three of them. Yet, collection agents sent by banks to chase repayment are harassing him. As amusing as this complaint may sound, it is the reality for at least 10-15 percent of borrowers, especially in the lower economic strata.

Now, who must take responsibility for this?

Indeed, the borrower must be aware of his repayment capacity or how much of his monthly income can be set aside to repay loans. But equally, evaluating this is the fundamental job of banks and non-banks before handing out a loan. Income assessment and evaluating a borrower’s debt service capabilities is the basic formality in the process of customer assessment.

If both of these have not been adequately done, how was the loan given in the first place?

It’s quite possible that when the first few loans were availed by the borrower, the customer had a good enough credit score—around the magic 770 mark—and that formed the basis of approvals. Subsequently, as the customer kept taking more loans, ideally, this should have reflected negatively on his credit score. However, it is quite possible that he was still considered a standard customer, and hence the credit score remained strong. However, at some stage when the default started to show, banks should have had an active tracking mechanism to gauge that the customer’s propensity to miss his repayment schedule was going to be higher. This is seldom the case. Unfortunately, credit scores are tracked and assessed only at the time of lending, not continuously throughout the tenure of the loan.

In other words, the deterioration in the credit score or the reasons for its deterioration remain untracked.

With a host of fintech lenders waiting to entice the urban middle class with small-ticket loans, regardless of their credit score—whether to upgrade a mobile phone or buy an air conditioner—it is only natural that indebtedness is bound to increase.

As indebtedness increases, the probability of default also increases. Defaults first show up on credit cards and personal loans (including consumer loans) and eventually spread to vehicle loans and home loans. Back during the pandemic phase, banks were flushed with liquidity, and fintechs had newly minted private equity money. Therefore, when times were good, credit scores or repayment capabilities didn’t seem like daunting pressures. But as the famous Warren Buffett quote goes: "Only when the tide goes out do you discover who's been swimming naked." In this case, it points to the lenders.

With no early warning mechanism to detect a customer’s declining repayment capabilities, one can only delay the side effects of overleveraging in the system—not completely avoid the self-made problem.