A Stitch in Time Saves Nine: RBI Ticks The Right Box In Tightening Rules For Retail Loans

The central bank increased the risk weight on consumer credit (excluding loans for education, housing and vehicles, and gold mortgage) by a fourth, from 100 per cent to 125 per cent – meaning if a bank had to set aside Rs 80 for a loan of Rs 1,000, it will now have to set aside Rs 100 in capital. Risk weights for credit card receivables were increased to 150 per cent.

The decision of the RBI came after weeks of cautioning lenders about the runaway credit growth in certain segments, such as personal loans and credit card spend, which the central bank deemed to be worrisome.

As corporate demand for new loans remain subdued in the absence of any major stimulus to broader economic growth, banks and non-banking financial companies (NBFCs) have been focusing more on retail and personal loans to keep their portfolio growing. While credit card outstandings have surged 30 per cent year on year, personal loans have grown at a 25-per cent pace – numbers that the RBI sees as rather discomforting.

Banks and non-banking financial institutions, however, insist that their exposure to unsecured loans is limited. Yet, in response to the RBI announcement, the share prices on several leading Banks and NBFCs, including State Bank of India, RBL Bank, L&T Finance and Aditya Birla Capital, fell sharply between 3 per cent to 8 per cent in Friday’s stock trading.

According to an estimate by the research division of the State Bank of India, the banking industry would need Rs 84,000 crore in additional capital to comply with the latest RBI directive. In other words, it would have the same impact as a 50-60 basis point increase in capital adequacy ratio, the SBI report said.

Rating agency S&P Global almost made a similar forecast. “The immediate effect will likely be higher interest rates for borrowers, slower loan growth for lenders, reduced capital adequacy, and some hit on profits. We estimate that the Tier-1 capital adequacy of banks will decline by about 60 basis points,” it said in a statement.

NBFCs “will be worse affected as their incremental bank borrowing costs will surge, in addition to the capital adequacy impact," the rating agency said. However, "slower loan growth and an increased emphasis on risk management will likely support asset quality in the Indian banking system.”

Some experts and industry players have termed the RBI decision as being somewhat overcautious. They point to the average ticket size of retail loans, which continues to be small and therefore bears limited impact on the overall loan portfolio of banks and NBFCs despite a sharp rise in the number of borrowers in this segment. Also being cited is the decline in the share of the subprime loans – which carry the highest risk of default – in total loan portfolios of banks, from 30 per cent in 2021 to 24 per cent in 2024.

That said most people see merit in RBI’s action, especially the timing of it. Although the delinquencies have not reached an alarming level, they are on the rise and it is prudent to assume they would rise further in the absence of regulatory curbs. That’s what the central bank just sought to do.

According to data available with the Credit Information Bureau (India) Limited (CIBIL), the proportion of credit active consumers availing small-ticket personal loans has steadily increased through the pandemic years, from 3 per cent in June 2019 to 8 per cent in June, 2023.

Worse, in the July-September quarter of 2023, about half (or 51 per cent) of consumers who availed small-ticket personal loans already had more than four credit products at the time of taking another new loan. The proportion of such consumers stood at 17% in the same quarter four years ago, in 2019. If one could describe this category as distressed borrowers, their numbers would seem to have grown three-fold in the past four years.

The RBI’s directive, therefore, could also be addressing a bigger crisis in the making – a crisis that is not just limited to the health and stability of the financial sector, but one that affects social balance and larger economic well being.