The Reserve Bank of India’s recent measures to tighten norms for unsecured retail loans will help strengthen underwriting norms through higher risk-weighted assets and is “credit positive” because lenders will need to allocate higher capitals for such loans improving their loss-absorbing buffers and may dampen their growth appetite, Moody’s Investor Service said in a note.

“The unsecured segment has been growing very rapidly in the past few years exposing financial institutions to a potential spike in credit costs in case of sudden economic or interest rate shocks,” it said.

The RBI on November 16, raised risk weights on riskier unsecured retail loans and credit cards by banks and NBFCs by 25 percentage points.

India’s unsecured lending segment has become very competitive over the past few years with banks, NBFCs and fintechs, including several new entrants, aggressively growing loans in this category. In the past two years, personal loans grew around 24 per cent and credit card loans grew 28 per cent on average compared with overall banking sector’s credit growth of around 15 per cent.

“Several NBFCs, which until now focused on secured lending categories such as infrastructure, real estate and vehicle loans, have also pivoted to these riskier segments. The net interest margins for such loans are also declining because of steep competition,”Moody’s said.

Further, several banks and NBFCs are sourcing unsecured loans through fintech companies’ apps. However, fintechs’ loan origination and collection models are largely untested and could expose the NBFCs and banks to asset quality volatility, it added.

Capital impact

Moody’s expects banks to be able to absorb higher risk weights on their capital because the overall banking sector’s exposure to unsecured retail credit is small at around 10 per cent as of September 2023. Moreover, the sector’s overall capitalisation is at a historically high level, with a Common Equity Tier 1 (CET-1) ratio of 13.9 per cent as of March 2023.

However, the impact of the new underwriting rules could vary among individual lenders depending on their exposure to unsecured loans, it said.

The central bank’s decision to also increase risk weights on banks’ exposure to NBFCs by 25 percentage points will be applicable to NBFCs which until now benefitted from risk weights below 100 per cent because of their higher domestic ratings. The strain, though, should be minimal because the higher risk weights are not applicable to loans extended for housing finance and priority sectors such as agriculture and MSMEs, among others.