The issue of high growth in unsecured loans has been widely talked and written for most of this year and we finally have the Reserve Bank of India increase the risk weight on categories of unsecured loans such as credit cards, consumer durable loans and personal loans. Bank on-lending to non-banking finance companies catering to this segment will also see an increase in risk weights against the existing practice of setting aside 100 per cent capital towards these loans.
What is exempted are those in the priority sector loans category including microfinance loans. The move is well intended and will certainly change the way unsecured loans are being lent.
But the question is whether the move is holistic and addresses some of the basic concerns in unsecured loans, including the practice of evergreening, which the regulator is quite aware of as a practice resorted to by a few lenders.
Increasing risk weights can have two direct implications. The requirement for capital will increase which consequently can slow down the pace of loan growth. But here’s the catch.
Capital position of banks could be affected between 70 – 150 bps and for non-banks the implication could be as high as 200 – 400 bps. In turn, if these lenders must tap the market for capital, there may have to bear a down round in valuations. However, most banks and NBFCs are well capitalised for the next year or so and the hit on valuations may not be scathing. From pandemic to now, given how their financials have improved internal accruals has adequately to feed into the capital pool. There is no reason to believe that this could change.
Second, and the more concerning aspect is pricing of loans. The logical next step with cost of doing business increasing, is to jack up the yield of doing the business. Many banks have started becoming cautious on pricing and the day of cheap loans are almost over.
But the problem with unsecured loans isn’t directly sitting in their books. Its more due to the fintech partnerships that they have entered and/or the indirect risk through lending to NBFCs.
Fintechs have neatly devised a model where the actual rate of interest doesn’t matter to the customer so long as the repayment bullets are within the borrower’s reach. This column delved into the flipside of such convenience repayment plans in the last edition (https://www.thehindubusinessline.com/specials/current-account/vault-matters-the-perils-of-overcustomising-repayments/article67493625.ece). Therefore, pricing may not really topple the apple cart in the near-term given the demand resilience.
Likewise, unsecured loans to salaried borrowers are straightforward. But what about to self-employed, which is presently the booming segment. These loans get tagged conveniently as priority sector loans and is excluded from higher risk weights. For another, take MFI loans. The trend today is migrating away from JLG (joint liability group) to individual borrowers, which is akin to a personal loan. But MFI loans fall in the exclusion list.
Therefore, while increasing the risk weights of unsecured loans is a significant step towards tapering growth, the move is too late. The share of unsecured loans has already risen to over 30 per cent of total retail loans from sub-20 per cent five years ago and lenders are innovating way to grow without revealing the true pain. Are we then truly addressing the elephant in the room?