What is the issue?
Share of unsecured loans are increasing in the economy which can expose banks to sudden risks.
What is the status of unsecured loans?
- An unsecured loan is a loan that is issued and supported only by the borrower's creditworthiness, rather than by any type of collateral.
- According to a Crisil Research, as of March 2018, outstanding unsecured loans stood at about Rs 5 lakh crore.
- It accounts for 26% of retail lending, compared with 21% three years ago.
- This is not altogether surprising since Indian banks are increasingly getting affected by wilful defaults on project loans to some of the largest industrial groups.
- This made them to turn to the borrowers at the other end of the spectrum in the form of retail loans to drive their growth.
- Thus, unsecured credit card debt and personal loans have become the fastest growing segments for banks in the last three years.
- It is expanding at a 30-31% annually while overall system credit has increased at just 8-9%.
- Also, unsecured retail loans, which make up less than 8% of outstanding bank credit, are growing at higher rates than before.
- This scenario warrant attention from bank risk managers and the regulator.
What are the concerns?
- Indian banks have had a bitter experience with indiscriminate retail lending during the previous boom.
- In the event of defaults, such loans offer negligible prospects for recovery.
- However, this shift in bank lending has no doubt served a felt need for the economy.
- In recent years, with a stagnated private capital expenditure, private consumption has been the key engine of India’s growth.
- Given that India is still a lower middle-income country, retail access to credit is imperative to sustain this consumption momentum.
- Hence, banks too are keen to push unsecured loans because they allow them to showcase strong credit growth while earning a return on assets as high as 3-4%.
- This has been witnessed with a quantum improvement in the quality of data backing credit card and personal lending in this economic cycle, compared to the previous one which went bust in 2008-09.
- This is also made possible with the advent of credit bureaus, data repositories on credit history and social media analytics.
- These technical interventions created the ability for lenders in monitoring their retail borrowers and to extend loans only to prime ones.
- But there are multiple lenders in the form of universal banks, small finance banks, NBFCs and microfinance institutions catering to the same retail segment.
- This intense competition will force a dilution of credit standards, leading to poor risk pricing and trigger a race to the bottom.
What should be done?
- To avoid this, public sector banks may need to increase the pace of technology adoption and build capacity in alternative credit scoring and data analytics.
- Acquiring retail exposures indirectly through securitisation or assignment deals with NBFCs or small finance banks is another option.
- Securitization is a process by which a company clubs its different financial assets/debts to form a consolidated financial instrument which is issued to investors.
- This enables the firm to raise capital and provide more loans to its customers.
- In return, the investors in such securities get interest.
- Traditionally, such niche lenders have managed low credit costs by concentrating in areas where they have last-mile reach.
- They can also hire local staff there and leverage on local communities to ensure good credit behaviour.
- But they have still proved vulnerable to liquidity risks and exogenous shocks, suffering a sharp spike in defaults during the economic downturn and demonetisation.
- Banks must thus be conservative with their exposure limits to unsecured retail loans, no matter how attractive their growth rates or yields may seem right now.
Source: Business Line
