Banks must hit a ‘pause’ on retail loans

Both the Report on Trend and Progress of Banking in India 2020-21 and the Financial Stability Report (December 2021) highlight consumer credit as the driver of the recent credit offtake. The latter report also points out that ‘sub-prime’ borrowers (CIBIL credit score below 680) in consumer credit is edging up.

In this context, it is worth quoting from a speech delivered at the National Institute of Bank Management, Pune. on April 18, 2018, by NS Vishwanathan, then RBI Deputy Governor: “There appears to be taking hold a herd movement among bankers to grow retail credit and the personal loan segment. This is not a risk-free segment and banks should not see it as the grand panacea for their problem riddled corporate loan book. There are risks here too that should be properly assessed, priced and mitigated.”

This view was also echoed in the Report on Trend and Progress of Banking in India 2018-19 . However, more importantly, the document presciently warned that “this diversification (from corporate to retail loans) strategy, while helpful as a risk-mitigation tool, has its own limitations: The slowdown in consumption and overall economic growth may affect the demand for and quality of retail loans.”

Against this backdrop, a look at the implications of the growth in personal loans (PLs) for (a) borrowers’ indebtedness, and (b) its sustainability from banks’ viewpoint.

PLs became the flavour of the season for banks from 2000s onwards, principally driven by the need to diversify credit risks following high incidence of non-performing assets (NPAs) in big-ticket loans. As illustrated in Chart 1, during the decade 2012-21, the outstanding PLs of scheduled commercial banks increased at a compound annual growth rate (CAGR) of 15.3 per cent, outstripping the CAGR posted by non-food loans (NFLs) at 9.4 per cent.

To assess household indebtedness, the indexes of outstanding PLs, Gross Domestic Product (GDP) and Gross Domestic Savings of the Household Sector (GDS-HH), all at current prices, were plotted, taking FY-12 as the base (=100).

Chart 2 clearly depicts the swift growth in PLs vis-à-vis GDP and GDS-HH each. The divergence between the growth trajectory of PLs and that of GDP and GDS-HH widened distinctly from FY16 onwards. The rapidly growing divergences don’t augur well for borrowers’ capacity to repay and, therefore, can adversely affect the health of banks’ PL portfolios. Increased borrower indebtedness combined with likely increases in NPAs has the potential to ultimately thwart the sustainability of PLs. Since the RBI data include the credit cards issued only by banks, not by their subsidiaries/joint ventures, the scenario could become grim, if all credit card outstanding are accounted for.

Chart 3 presents the broad bank group-wise Gross NPA (GNPA) ratios in respect of PLs. The Chart highlights an increasing trend in the GNPA ratios. For both bank groups together, the ratio ruled above two per cent from FY17 onwards. PSBs, which reported substantially higher ratios than private banks, remained much above two per cent throughout the seven-year period and brushed against three per cent in FY17 and FY21.

Stress in PLs had started building up from 2019-20:H1 owing to economic slowdown. The pandemic and moratorium added to the stress. This resulted in prominent private banks disposing of toxic retail assets to ARCs.

According to a PWC Report (May 2021), “increasing layoffs, deferrals/salary reductions, higher unemployment, and decreasing economic activity due to lockdowns contributed to a significant short-term liquidity crunch for many middle- and low-income borrowers… ”

The pandemic-induced stress is far from over, and the effects of disruption will be felt in the coming years.

The evident unplanned growth trajectory of PLs needs to be leashed before it goes awry. Conventional measures — that is, pre-sanction appraisal and post-sanction monitoring and follow-up — alone would not suffice. A few unconventional steps as discussed below would not only benefit banks but also calm down the likely indebtedness of the borrowers. Cross-country studies demonstrate the pernicious societal and psychological impact of excessive indebtedness emanating from runaway consumer credit expansion.

Banks need to press the ‘pause’ button and consolidate their position before embarking on another phase of PL growth.

Banks must frame potential-linked plans by weaving in appropriate macroeconomic variables like disposable income, employment situation and inflation on one hand and bank-specific variables on the other. For example, higher inflation increases the loan amount, but simultaneously erodes disposable income and savings of the households, making loan servicing difficult for them.

These aspects assume importance given the high debt illiteracy and exuberance to adopt modern standards of living among people.

Inter-bank coordination is important so that bank-level targets, fixed on silo basis, don’t become unsustainable, when aggregated. There are ways to approach this optimisation issue.

Concentration of PLs needs to be paid attention — by geography, target groups, segments, etc.

Banks need to give preference to those borrowers whose salary or income accounts are linked to their loan accounts for repayment.

Popularising credit cards is welcome, but the risk of elevated indebtedness cannot be ignored, a stage in which many developed countries are embroiled.

It is heartening to note that the Insolvency and Bankruptcy Code is considering measures to provide easier access and reduce the time and cost of insolvency proceedings related to individuals. At the same time, the market infrastructure for effective disposal of PL-financed assets should be fostered.

The role of financial literacy and credit counselling at the household level can no longer be ignored to foster a sound credit culture among the existing and prospective retail borrowers.

To conclude, preoccupation with mitigating corporate loan NPAs shouldn’t make banks oblivious to the issues edging out of excessive reliance on PLs as risk diversifier and income generator.

Das is a former senior economist with SBI and Rath is a former Chief General Manager with the RBI. Views are personal

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