What RBI terms as personal loans are known as retail loans in common parlance. These include housing loans, advances against fixed deposits, advances to individuals against shares and bonds, credit card receivables, education loans, vehicle loans, loans against gold jewellery, consumer durables loans and what you and I refer to as personal loans.
Das’ October statement was a clear sign about the Indian central bank getting worried about banks and non-banking financial companies (NBFCs) giving out retail loans—in particular, personal loans and credit card receivables—at a pace it wasn’t comfortable with. Both personal loans and credit card receivables are unsecured loans, in the sense that there are no underlying assets against which the borrowing has been carried out, like is the case with a housing loan, where the lending is carried out against the house which is being bought using the loan. In case of a default, the house can be sold and the bank can recover the outstanding loan amount. Such a facility does not exist in case of unsecured loans. Hence, they are more risky and their rapid growth has RBI worried.
On 16 November, RBI followed up Das’ October statement and announced that it was increasing the risk weights associated with retail loans and banks would now have to allocate more capital against the retail loans they give out. From this, the central bank left out housing loans, education loans, vehicle loans and loans against gold jewellery.
So, what does this mean? As per the current norms, for every ₹100 banks lend as personal loans, they need to set aside ₹8 as capital. The risk weight has been increased by 25% and given this, banks will now need to set aside ₹10 as capital for every ₹100 they give out as personal loans. This will have to be done not just for the new loans given out but also for the loans already given out.
Other than personal loans, banks will have to set aside more capital against the outstanding credit card receivables as well as the loans they give to NBFCs. The NBFCs will also have to set aside more money against their outstanding credit card receivables as well as the personal loans they give out.
Now, what does this mean? Banks and NBFCs will have to set aside more money when they give out certain kinds of retail loans, primarily personal loans and credit card receivables. The money that is set aside does not earn as much return as unsecured loans. Hence, in order to maintain their margins, they will need to earn a higher return on the loans they’ll end up giving out. This is likely to force them to raise interest rates. Higher interest rates will discourage prospective consumers from borrowing. And this will force down the loan growth to levels that RBI is comfortable with—at least, that is how it is supposed to work in theory.
The question is how did we end up here? In this piece, we will try and understand that.
The rapid loan growth
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In May 2022, RBI started to raise the repo rate—the interest rate at which it lends to banks. This was done in order to control inflation. But instead of loan growth slowing down, the growth of non-housing retail loans picked up. The non-housing retail loans figure was arrived at after subtracting housing loans from overall retail loans.
Interestingly, the non-housing retail loans had grown by 12.3% and 15.2%, in March 2022 and April 2022, respectively, in comparison to a year earlier, and before RBI got around to raising the repo rate. The growth in May 2022 stood at 19%. From June 2022 to September 2023, the growth has been higher than 20% in comparison to a year earlier. We have data on retail loans growth going back as far back as April 2008, and a 20% growth in non-housing retail loans for a period of 16 months has never been seen before. No wonder this has got RBI worried.
Of course, the aggregate does not always reveal the details well. While the growth in non-housing retail loans has been fast, the growth in credit card receivables and personal loans has been even faster.
Chart 1 plots the growth in credit card receivables and non-housing retail loans, from January 2022 onwards. As can be seen, the growth in credit card receivables has been way faster than growth in non-housing retail loans. This has been primarily on account of a rapid increase in the issuance of credit cards over the last few years. The number of credit cards as of September 2023 stood at 93 million, jumping 43% over a two-year period. Further, the growth in personal loans has been a little faster than the growth in non-housing retail loans.
In fact, even chart 1 does not really give us a totally clear picture. While banks give out personal loans and issue credit cards on their own, they also give out loans to NBFCs, which in turn give out personal loans and issue credit cards. So, while these loans end up as loans to NBFCs on the books of banks, a lot of it are really personal loans and credit card receivables. Take a look at chart 2. The lending by banks to NBFCs has shot through the roof in the recent past.
In June 2023, the growth in banks’ lending to NBFCs had stood at 35.1% against 7.8% in March 2022. The growth rate in September stood at 26.3%.
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The short-term reason
So, banks are directly and indirectly giving out more and more unsecured loans. When the growth of a certain kind of loan happens at a much faster pace than overall loan growth for a sustained period of time, as has been the case here, then chances are that financial institutions are giving out more loans by lowering lending standards and compromising on the quality of the borrower.
In fact, as per TransUnion CIBIL, a credit information company, during the period April to June 2023, “approximately half (51%) of consumers who availed small-ticket personal loans already had more than four credit products at the time of availing another new loan, compared to just 17% in that category in Q2 2019 [April to June 2019].”
A small ticket personal loan is defined as a personal loan of less than ₹50,000. In fact, since January 2022, small-ticket personal loans “while representing a very small share of total retail balances, have accounted for approximately 25% of total origination volumes”.
A possible explanation for this lies in the fact that fintechs have gone aggressive on giving loans in the recent past. In order to carry out lending, fintechs get into an alliance with banks or NBFCs. This explains a surge in small personal loans. Now, the fact that more than half of those taking on small-ticket personal loans already have more than a few loans clearly suggests some dilution in lending standards.
Fintechs are largely funded by venture capitalists and are more interested in driving up business, so that they can drive up their valuations. This explains the supply side of loans. On the demand side, a possible explanation lies in the fact that post the pandemic, the Indian economy has been going through a K-shaped economic recovery, with the less well-off being in weak financial shape. And that has possibly forced them to take on more small-ticket personal loans. Hence, the demand for small-ticket size personal loans may have gone up. Of course, when it comes to personal and retail loans of higher amounts, the post-pandemic revenge consumption of the well-to-do might be at work as well.
The long-term reason
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In the years gone by, Indian banks primarily lent to industry, but as can be seen from chart 3, that has gradually changed over the last decade. In early 2013, bank lending to industry peaked at over 46% of non-food credit. It has been gradually coming down since and, in September 2023, stood at 22.9%. Banks give out loans to the Food Corporation of India and other state procurement agencies to primarily buy rice and wheat directly from farmers. This is referred to as food credit. Once this is subtracted from overall bank lending, what remains is non-food credit.
The retail lending by banks has been gradually going up and in September 2023 stood at 31.9%. This figure is slightly bumped up due to the merger of HDFC with HDFC Bank. HDFC was a housing finance company and not a bank. Housing loans given by HDFC were not counted under housing loans given by banks. But with the merger, these housing loans are now being counted under housing loans given by banks. Now, given that housing loans are retail loans, the ratio of retail loans of banks to non-food credit has jumped up post the merger on 1 July.
In June 2023, before the merger, retail loans as a percentage of non-food credit had stood at 29.7%.
What this tells us is that banks on the whole and public sector banks (PSBs), in particular, haven’t really come out of the lending binge to corporates that ended very badly. The interesting thing is that in the year ending March 2023, the retail lending of PSBs grew by 19.1%, the highest since the year ending March 2011. Credit card receivables grew by 25.6%, after growing by 65.3% in the year ending March 2022.
In comparison, in the year ending March 2023, the retail lending of private banks grew by 21.8% and credit card receivables grew by 33.5%.
This data tells us clearly where the long-term focus of banks is. They want to give out retail loans, simply because it’s less risky to do so in comparison to giving loans to industry. Of course, the choices within the overall retail loans bouquet will have to keep changing depending on whatever is the flavour of the season.
Any reason to worry?
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As the old cliché goes, once bitten twice shy. In the last cycle, the gross non-performing assets rate or the bad loans rate of banks had peaked at 11.2% as of March 2018. This was primarily on account of corporates taking on loans from PSBs and then defaulting on them. As of March 2023, the bad loans rate stood at 3.9%. Bad loans are loans which haven’t been repaid for a period of 90 days or more. When expressed as a percentage of total loans given by banks, we get the bad loans rate.
Now, the question is will this lending binge in retail lead to further trouble for banks. In total, the credit card receivables and personal loans given out by banks form around 9.6% of the non-food credit. Also, the small-ticket personal loans, where the risk of default seems to be the highest, form an insignificant portion of the overall loans given by banks. Having said that, the fintechs could face some trouble here, given that they seem to be lending to borrowers who already have too many loans.
Further, loans given by banks to NBFCs formed around 9.4% of non-food credit as of September 2023. Now, a breakdown of what NBFCs use these loans for is not available at an aggregate level in the public domain. Nonetheless, it is safe to say that NBFCs have a much greater proportional exposure to personal loans. As per a recent report by Jefferies India, unsecured personal loans made up 37% and 21% of the loan books of NBFCs like Bajaj Finance and Aditya Birla Capital.
Also, it is worth remembering here that unlike corporate borrowers, it’s not very easy for retail borrowers to default on a loan, given that the full fury of a bank’s or an NBFC’s legal and other means can be unleashed on them.
Finally, the question is if RBI’s move asking banks and NBFCs to set aside more capital lead to higher interest rates and a slowdown in the growth of the non-housing retail loans. On that your guess is as good as mine.
Vivek Kaul is the author of Bad Money.