At the root of the regulator’s concerns over growth in unsecured lending are interconnectedness, lending apps and algorithm-based underwriting. The flurry of actions — raising risk weights on unsecured loans and bank credit to NBFCs, cautioning banks on surveillance, underwriting and dark patterns in lending — has turned the spotlight on a small but growing segment of the credit market. The Reserve Bank of India (RBI) appears especially worried about the growth in credit card debt and general-purpose unsecured personal loans, for which it raised risk weights. Though these two have a small share in total credit (1.4 percent and 8 percent, as of September 2023), their rapid growth of 30 percent and 25 percent, respectively, was worrying because it raised the spectre of non-performing assets (NPAs), which though currently low, (2 percent in credit card debt and 2.9 percent in overall personal loans) were rising and could spiral out of control if growth was unchecked.
Purpose Agnostic Lending
There are perhaps two reasons why these two segments invite attention. One, credit card debt and unsecured personal loans, both being purpose-agnostic, tend to be lender-driven and prone to exuberance. Besides, there are many players now — fintechs, lending aggregators and lending apps — who are not under the direct regulatory ambit of the RBI. Even though they can do business only through regulated entities, activities such as customer acquisition, underwriting and risk assessment are still outsourced. While digital lending guidelines are in place, these are more principle than rule-based, with the onus on regulated entities. The other personal loan categories such as housing, vehicles and education are more purpose-specific and tend to move in tandem with market and economic conditions which can check unfettered growth.
Second, delinquencies tend to be higher in unsecured categories especially if underwriting is lax. The spate of recent incidents like the digital onboarding scam and the misselling of EMI/online shopping credit by some NBFCs are a few pointers to the dangers arising from digital lending. With technology in the picture (apps, algorithm-based credit evaluation), regulation can be challenging, which is perhaps why making credit more expensive seems a better alternative. Whether this will work remains to be seen because, for one, players may choose not to pass on the entire increase in cost. But more importantly, these segments are not as rate-sensitive as other personal credit.
RBI data on interest-rate-wise outstanding loans show that over 98 percent of credit card debt is already in the highest bucket (over 13 percent interest rate). Credit card debt is a classic example of a seller-driven product where ancillary features such as benefits/rewards drive sales more than the cost of credit. But unsecured personal lending for general purposes could feel some pinch. A little over half of this debt is under 10-12 percent interest rates, while another quarter is under 12-13 percent. This segment also has some interesting features. As per a recent Trans Union CIBIL research report on Indian fintech lending, nearly 80 percent of fintech personal loans that originated during 2022-23 were under Rs 10,000, with 73 percent of the loans being of six months or lower tenor. The small size and tenor of credit suggest continued refinancing or rolling over, which also may be the reason why the share of new-to-credit (NTC) borrowers has been continuously declining. To be sure, these loans are reflected in the loan books of NBFCs and banks, but outsourced origination and evaluation add a large element of risk. The RBI has especially been wary of lending apps which have proliferated as also the misuse of technology through dark patterns which could jeopardise customer interests. The RBI has made the right moves and hopes to get this segment under control through the twin measures of cost of credit and regulatory exhortations.
Fears Over System Risks
At the macro level, the RBI’s apprehensions are about systemic risk from defaults in unsecured credit. With NBFCs heavily dependent on banks and mutual funds (MFs) for resources, their asset quality directly impacts the portfolios of banks and MFs. The RBI’s Financial Stability report says that MFs are the largest suppliers of funds in the system after banks. But banks’ exposure on a net basis is negligible as they lend and borrow largely amongst themselves. However, MFs and insurance companies are net lenders; for instance, under their debt schemes, MFs are exposed to NBFCs and banks to the extent of almost 25 percent. What is more, nearly 70 percent of it is in short-term (90-180 days) instruments.
With the ILFS debacle fresh in memory, the RBI has been exhorting NBFCs to diversify their resource base away from banks. But this is easier said because the larger problem is with the nature of the debt market itself. It is dominated by a few large players (banks, insurance companies and pension funds) with the bulk of their resources being pre-empted by the government, which hardly makes for any secondary trading possibilities. Even private placement of corporate debt is mostly by the financial sector (NBFCs and banks). With borrowers and investors being from the same segment, there is effectively only a round-tripping of liquidity between banks, MFs and NBFCs, which means there is no escaping systemic risk irrespective of where debt is sourced.
SA Raghu is a columnist who writes on economics, banking and finance. Views are personal and do not represent the stand of this publication.
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