In view of rapid growth in retail loans, policymakers may consider using structural prudential tools such as debt-service ratio and debt-to-income ratio to assess viability of retail borrowers, according to an article in RBI’s latest monthly bulletin.

The aforementioned recommendations come in the backdrop of persistent credit growth in certain segments of retail credit prompting RBI to announce pre-emptive measures on November 16, 2023, to sober down undue exuberance which was visible.

Risk weights on certain segments of consumer credit were enhanced by 25 percentage points. The issue of interconnectedness through bank lending to NBFCs was also addressed through higher risk weights.

Surge in retail credit growth

“The Indian economy is witnessing a surge in retail credit growth. The credit growth is led by a well-diversified customer base, with reasonably good financial health conditions barring a few pockets of incipient weakness,” said RBI officials Vijay Singh Shekhawat, Avdhesh Kumar Shukla, ACV Subrahmanyam and Jugnu Ansari in their article “Dynamics of Credit Growth in the Retail Segment: Risk and Stability Concerns”.

Therefore, the recent trends underscore that it is imperative for banks and other financial service providers to monitor the retail segment closely and continuously for any undue build-up of stress.

Between 2015 to 2023, the personal loans or retail credit registered a compounded annual growth rate (CAGR) of 17 per cent in outstanding amount and 15 per cent in borrower accounts. Against which, non-food credit registered a CAGR of 10 per cent in outstanding amount and 12 per cent in borrower accounts.

The authors noted that while the extant macro prudential tools impart lender resilience by specifying differential risk weights for various classes of retail products reflecting their inherent riskiness (for example, under the extant prudential guidelines, credit cards and personal loans carry higher risk weights than housing loans), policy makers are encouraging lenders to use emerging technology ecosystem -- account aggregators, to seek requisite consent from the borrowers; strengthen credit underwriting; and strengthen monitoring of models.

Besides enabling greater flexibility both in terms of product and pricing choices for the borrowers, such frameworks facilitate monitoring of borrower leverage in a holistic fashion.

“This can be further extended by prescribing debt-to-income (DTI) limits for certain borrower or product categories. DTI limits along with restrictions on loan-to-value (LTV) ratios are found to be effective macro prudential tools, that can be synchronized to contain systemic risks,” the authors said.

Also, such macro prudential tools can be quickly calibrated in line with the evolving macro-economic situations to support or dampen the credit growth.

The authors analysis shows that the composition of retail credit has been changing over time. The share of unsecured credit within the retail credit has been rising.

“Between 2007 to 2023, the share of unsecured advances in retail credit increased from 25 to 35 per cent. As opposed to this, the share of major segments representing the secured credit remained stable. The housing loans continue to be the single largest sub-segment, constituting around 48 to 50 per cent of retail credit, the vehicle loans constituted the second largest segment accounting for about 10 to 12 per cent share,” they said.

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