How serious is the scare about unsecured loans?

Ever since the RBI governor expressed his worries over the fast pace of growth of unsecured debt in banks and NBFCs, financial markets have been abuzz with speculation as to how big the problem is. The following is an effort to put all the data available on the matter so readers can judge for themselves.

First, let us note what the RBI governor said: He importantly didn’t say that NPAs are rising. Quite the contrary. The governor said, “In certain segments of retail credit, we saw high credit growth. So, it is only to caution the banks to strengthen their internal surveillance systems, watch the trends, and take whatever measures are required".

Elaborating on the point, Deputy Governor Swaminathan said, “Unsecured loans have been growing at 23% for the last couple of years; while other verticals like corporate, SME are growing by 12–14%. We want to sensitise banks that this is an outlier."

So for starters, the RBI’s worry is the pace of growth of unsecured credit, and the numbers justify the worries. Table 1 shows that unsecured loans have consistently grown close to 25% since FY19 (barring the one COVID-19 year), while retail loans have grown only in high teens and overall credit even more slowly, i.e., in low teens, except for the latest year.

Not surprisingly, the share of unsecured loans in total retail loans has been climbing, as Table 2 shows (Source: Crisil). Unsecured loans are also growing as a share of overall credit.

So should we worry? "No", says SBI economist Soumyokanti Ghosh. In a recent report, Ghosh shows that banks are already bringing down the number of first-time loanees or what are called new-to-credit customers (these typically don’t have credit scores and can be risky). Table 3 (taken from Ghosh’s report) shows that banks have also brought down their exposure to subprime borrowers and increased loans to prime, prime-plus, and super-prime borrowers.

Ghosh argues that individual banks that have reported Q2 results have all shown a fall in NPAs. (See Table 4).

Crisil’s Krishnan Sitaraman points out that not just for individual banks, but even for the banking system as a whole, NPAs have come down, and what’s more, NPAs in the retail category and the unsecured retail category have also come down. (See table 5). Even potentially stressed loans like SMS1 & SMA2 loans have come down from 4.2% as of March 2021 to 2.3% as of March 2023 ( Alert: SMA1 refers to loans where interest hasn’t been paid for over 30 days & SMA2 is loans where dues are unpaid for over 60 days).

As for NBFCs, SBI’s Ghosh says, yes, retail loans are rising, but they are nowhere near their past highs.

NPAs with NBFCs too have been coming down from 6% of the book in mid-2021 to 4% of the book in mid-2023, as Table 7 shows. (Source: SBI Report)

Then why the worry? Credit bureau CIBIL shared some numbers which may be considered red flags: CIBIL says all the 3 major subcategories of retail unsecured loans – i.e. credit cards, personal loans, and consumer durable loans have seen their NPAs rising (albeit modestly) in the past one year as Table 7 shows. (Source: CIBIL)

CIBIL pointed out another worrying data set. It says loans under ₹50,000 are a specially stressed category. The NPAs in this category have risen from an already high 4.2% in June 2022 to 5.4% in June 2023.

Banks and NBFCs are still showing declining overall NPAs.

Then why is the regulator warning, and warning repeatedly?

Firstly, they worry that these small loanees (taking loans under ₹50,000) from fintechs may have an auto loan with a bank, which will go bad due to over-borrowing.

It is these wrong tendencies that RBI wants to curb.

In short, no, the unsecured loans do not pose a systemic threat. In fact, as the RBI DG Swaminathan clarified they do not want to impose risk weights (i.e., ask banks to set aside more capital per loan). They think an advisory is enough. That by itself reflects the regulator’s confidence that the problem is not severe. An advisory to banks to strengthen their internal surveillance and due diligence should suffice for now says the regulator. But if the unsecured loans continue to grow at a faster clip and banks or NBFCs show some unsavoury practices, the regulator may act at a future date.

For now, the health of the banking and NBFC sectors seems to be robust.