Sustained high growth in unsecured retail loans can increase the risk of mispricing and misjudgement, which could have a direct impact on financial performance of banks, if operating conditions turn less favourable, according to Fitch Ratings. 

Further, while heightened regulatory attention on unsecured loans could moderate their growth, this loan segment could still be a risk for banks like State Bank of India, ICICI Bank and Axis Bank, where unsecured personal loans and credit cards form a sizeable share of the loan mix.

“Underwriting quality and risk controls will remain key, given the banks’ heightened interest in unsecured retail loans, where growth has well-exceeded the overall loan book growth,” Fitch said in a note, adding that the risk profiles of Indian banks remain closely linked to their asset quality scores and reflect their above-average risk appetite given their growth aspirations and the amount of unseasoned loans building up.

“The influence of legacy stress on asset quality has been gradually waning, but increasing growth and risk appetite in the currently benign credit cycle will test banks’ enhanced risk frameworks once operating conditions turn less favourable,” it said.

On an overall basis, sectors such as non-banks, renewable energy, roads, steel and textiles have been the key growth areas, although the bulk of the lending continues to be short-term.

Banks with risk profiles in the ‘bb’ category such as State Bank of India, ICICI Bank and Axis Bank reflect slightly more diversified risks and better asset-quality performance compared with those in the ‘b’ category such as Punjab National Bank, Union Bank and Bank of India.

Banks with higher scores also have an advantage in selecting exposures due to their stronger local franchises and brand recall. However, the lack of detailed information on fresh risks undertaken in the retail and SME sectors weighs on Fitch’s assessment, it said.

Loan growth

Loan growth was brisk across banks in FY23, with SBI, Bank of Baroda, Canara Bank, ICICI Bank and Axis Bank outperforming sectoral growth. While growth and appetite for unsecured personal loans have risen sharply, the share of personal loans is quite low for most state banks.

“While retail risks are easier to manage due to high granularity, moderate household leverage and faster recoverability, unsecured loans are inherently riskier as banks have limited visibility into the end-use of funds.”

Even so, the asset-quality scores for all rated banks have positive outlooks and their impaired-loan ratios are expected to improve further in FY24, it said, adding that the average impaired loan ratio for the sector is estimated to have improved to 3.6 per cent in Q1 FY24 from 4.0 per cent in FY23.

Fitch revised upwards the scores for several ‘b’ category banks in 2023,to factor in the better-than-expected performance, which is expected to continue in the near term.

It expects banks’ loan-to-deposit ratios to remain under pressure in the near future, with private banks feeling more of an hit. While expanding the deposit franchise is a management priority for nearly all banks, it will be more so for the private players considering their ambitious growth plans.

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