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.
