The RBI’s recently released monthly bulletin has argued that the quality of retail loan portfolios is healthy except for credit cards and vehicle loan segments which recorded moderate stress.

In November last year, the RBI tightened the norms related to unsecured loan portfolios of banks and non-banking financial companies (NBFCs), citing abnormally high credit growth in these loan categories. What did the RBI exactly do? Raising the risk weights on these loans from 100 per cent to 125 per cent increased the capital that banks and NBFCs are required to set aside for every personal loan they disburse.

The norms apply to most personal loan segments, such as credit cards, but exclude education loans, housing loans, and vehicle loans. In simple terms, banks and NBFCs now need to set aside the disbursed amount of personal loans and an additional 25 per cent as capital. The risk weight of all credit card receivables is now 150 per cent for banks (increased from 125 per cent) and 125 per cent for NBFCs (increased from 100 per cent).

One view is that such moves are countercyclical, aimed at stabilising and regulating the economy by reining in the adverse effects of an upswing in the business cycle. Moreover, it is meant to send a signal to the financial system to control any emergent financial stability risk.

What are the implications of the tightened norms? First, the capital requirements of banks will increase by ₹84,000 crore (as estimated by the State Bank of India), thereby enhancing borrowing costs as the lenders pass on the elevated capital charges in the form of higher lending rates.

Second, it can reduce loanable funds available with financial institutions as those lenders who are unable to set aside additional capital would have to cut down on lending. Consequently, it may reduce the spending of retail consumers as they are able to borrow less than before. Hence, this change in the lending norms may be categorised as contractionary prudential policy — as it leads to a reduction in aggregate consumption, which may lead to a contraction in economic activity, i.e., send the business cycle to a downward trajectory. Bank loans to NBFCs have also been assigned a 25 per cent higher risk weightage, over and above the risk weightage given by external agencies (in case the latter is less than 100 per cent). This move will further reduce lending activities, suggesting a costly trade-off between financial stability and credit growth.

Is the RBI justified in tightening the lending norms? A close inspection of the latest data shows that the growth rate in personal loans by banks is on a declining path after reaching a peak in July 2023. The growth rate in credit card outstanding by banks is also decreasing since June 2023, when it reached the highest level in the previous one year. Both personal loans and credit card outstanding have been stabilised after the growth rates converged in June-July 2023. The year-over-year (y-o-y) growth rate seems to be high but the general trend in the growth rate is not alarming. While it is following an imperceptible upward movement, so is economic growth in the country.

Moving to NBFCs, the growth rate in their total loans over the last one year has been on a declining trajectory. However, a spike in growth can be seen in June-July 2023. Moreover, the growth rate in September 2023 is marginally lower as compared to August 2023. The category ‘Other Services Loans’ which include ‘Mutual Funds and Banking’ and ‘Finance Other Than NBFCs’ has been on an upward trajectory since the last one year, only to see a modest decline in September 2023, but it did not receive any attention from the regulator. The loans under ‘Other Services Loans’ amount to ₹8.5-lakh crore, as on September 22, 2023.

The RBI’s major concern seems to be the ‘lifestyle related’ loans up to ₹10,000 of 3-4 months’ tenure. However, the tightened norms apply to all the types (short-term and medium terms loans) and tenures (up to 7 years) of personal loans. No specificities regarding types and tenures can be seen in the new norms. It appears to penalise all types of personal loans and credit card outstanding. Perhaps the RBI would have done better by adopting a more calibrated approach by targeting those loan categories that are prone to high risk instead of a one-size-fits-all perspective.

Diagnosis of repayment

Since the RBI is concerned particularly about the smaller amount and shorter-term loans, a diagnosis of repayment trends in this category is important. The impact of defaults in this category of loans are generally less, firstly because of digital collections system introduced by many banks. For instance, SBI has employed two fintechs for monitoring and collecting digital loans in the northern region on pilot basis. This has an advantage of alerting the bank in case of any adverse trend in the payment behaviour of the borrowers.

Secondly, low level of exposure in the personal loan segment of banks helps to keep the losses from default under control. For example, the share of personal loans in total domestic loans given by Bank of Baroda is just 3 per cent in the month ending June 2023. The gross non-performing assets (NPAs) stood at only 1.13 per cent in the personal loans segment. It seems, this segment of loans may not be a big risk to the system at this point in time. Historically (since 2015), at aggregate level, NPAs for retail loans have been the lowest among all segments of loans, according to the RBI’s monthly bulletin. Similarly, the slippage ratio, which indicates the rate of accretion of NPAs, is the lowest for the retail segment.

There is no doubt that checks and balances are a pre-requisite for ensuring a sound financial system. However, a targeted approach would be more appropriate than a cookie-cutter model to ensure a balance between financial stability and growth.

Sensarma is Professor of Economics at IIM Kozhikode and Ansari isProfessor of Economics at IIM Kashipur (Uttarakhand)