Indulgent Personal Loan Borrowers Face A Moment Of Reckoning

Suraj Kumar is under a pile of debt. In about six years, his burden has doubled to Rs 16 lakh.

The Mumbai-based media professional has at least six credit cards from different banks in a desperate effort to repay the personal loans taken from non-bank lenders since 2017. What started as an easy solution to arrange funds for personal use has now led to a mountain of financial troubles.

Either way, Kumar (who didn't want to disclose his real name) will not be able to opt for another personal loan hereon, especially after the Reserve Bank of India increased risk weight on unsecured personal loans and credit card receivables by all lenders. This is likely to push up the cost of borrowing for retail users, making it difficult for those like Kumar to refinance their debt.

The lending rates on personal loans are likely to rise by 50–100 basis points across the system, owing to the RBI's move, said bankers. Currently, personal loans are priced at 10–15% on an annual basis. Any increase in rates would inevitably slow down personal loan growth, at least for a while, bankers said.

Under the RBI's tighter norms, unsecured personal loans will attract a credit risk weight of 125% compared with 100% earlier. For non-banking financial companies, consumer loans will attract a risk weight of 125%. In case of credit card debt, these have been raised by 25 percentage points to 150% and 125% for banks and non-banks, respectively. The tougher norms exclude home, education, vehicle, gold and microfinance loans.

As a consequence, banks and NBFCs would have to adjust their lending practices to meet the new capital requirements.

For some well-capitalised banks, the 25-percentage-point increase is not significant to compel a curb in unsecured credit as they can absorb the hit without passing on the costs to borrowers, according to bankers.

State Bank of India Chairperson Dinesh Khara, however, said the RBI's new norms would naturally bring down unsecured credit growth for the banking system.

"Currently, unsecured credit growth is overrated, and there is a need to bring it down," Khara had said on the sidelines of the FIBAC 2023 Conference. "Rise in risk weights will impact SBI's capital adequacy by 60–65 bps." India's largest bank has sizable exposure to unsecured retail loans, at about 13% of total loans, of which 9% are personal loans.

Exuberance In Unsecured Lending

Since the beginning of 2020, personal loans in the Indian banking sector grew around 82% and credit card loans grew 105%, compared with overall banking sector's credit growth of around 72%, according to the RBI's data.

The pivot in consumer behaviour after the coronavirus pandemic had led to a manifold surge in unsecured personal loans, particularly for consumption. Ballooning household debt has also pushed borrowers to tap unsecured credit to refinance their earlier dues.

The RBI's latest report shows that the household savings in India slumped to a 47-year low at 5.1% of the gross domestic product in the last financial year, mainly on account of a rise in household financial liabilities. This implies that people are relying more on borrowings to cover their consumption demands.

This is the "exuberance" in consumer credit, RBI Governor Shaktikanta Das said at the FIBAC event, calling the increase in risk weight is a pre-emptive measure and lenders must stress-test their loan books.

At least, anecdotal evidence suggests the governor's caution is warranted.

Ayush Yadav, a 21-year-old student based out of Bengaluru, took multiple small-ticket loans from January this year from two fintech platforms. He pays an interest rate as high as 55% per annum.

While he can take a loan up to Rs 10,000 only at such convenience, he will not be able to afford another such personal loan if the interest rates increase too much, Yadav said. A loan exceeding Rs 10,000 would require him to provide salary slips, which he cannot furnish.

Adhil Shetty, chief executive officer of BankBazaar, suggests borrowers must cut down on discretionary spending and use savings to repay the loan.

"Small-ticket personal loans will become harder to find because the cost of capital is going up on them," Shetty said. "Consumers with a credit score below 750, who want to take a small-ticket personal loan, the supply is going to shrink for them."

Das has also stressed upon the need to account for risks while pricing of such loans. While most bankers say that the risk assets are adequately priced to bear the extent of build-up in stress in unsecured credit, some hold a different view.

Inappropriate pricing of risk assets is a "little alarming," according to PR Seshadri, CEO of the South Indian Bank Ltd. This points at a possibility of increase in lending rates. In the September quarter, the South Indian Bank's personal loan book grew 48% year-on-year to Rs 2,107 crore.

"We need to be paid for the risk that you are taking," Seshadri said. "We believe that in certain categories, the pricing is not appropriate."

"In terms of convenience, personal loans will always grow quickly," the South Indian Bank CEO said. "But the growth rate in personal loans across the sector will moderate."

Delinquencies May Rise Temporarily

In the last monetary policy meeting in October, the RBI governor had cautioned against the risks of "very high growth" in personal loans and urged lenders to strengthen their internal surveillance mechanisms and address the build-up of risks.

As banks are most likely to become more risk-averse due to increased credit risk weight, they may tighten their lending criteria.

Borrowers, especially those with lower credit scores or in sectors perceived as riskier, may find it harder to qualify for loans or may face more stringent approval processes. More so, the borrowers who rely on such loans for funding requirements would be in a fix.

This would eliminate a large section of borrowers and result in an increase in delinquency levels for a while.

As the measure itself is aimed at containing stress in personal loan segments and is a pre-emptive move, analysts said it is still early to assess any long-term impact on asset quality.

"Any event, which restricts credit flow, could result in some kind of buildup in overdue. This holds true for most loan segments," AM Karthik, sector head-financial sector ratings at ICRA Ltd., said.

"So, whatever headline stress seen at this point in time could be absorbed considering the provision and capital buffers of the lenders, but any further buildup of stress is certainly contained by this new regulation," he said.

A part of the potential rise in delinquencies in the coming months would be on account of stricter underwriting measures taken by banks and NBFCs at the time of disbursing unsecured credit, analysts said.

"They will be a bit more prudent," Karthik said.

However, the base situation is that any rise in delinquencies due to inability of borrowers to finance their debt through personal loans would be offset by no or lesser incremental stress from tighter underwriting measures.

In such a situation, Kumar has no other option than to follow what BankBazaar's Shetty advises: manage cash flows to repay the hefty amount of Rs 16 lakh.

Also Read: RBI Increase Of Risk Weights On Unsecured Loans Is Credit Positive, Says Moody's