Unsecured loans - personal loans and credit cards - reached Rs 16.97 trillion and accounted for over 10% of total bank credit in May'24. The central bank is closely monitoring this for signs of incipient stress. In Nov'23 RBI increased the risk weights of these products. The transmission happened without much lag. Most banks have raised their MCLR. The second identified risk - credit to NBFCs - raises the concern of asset liability mismatch. Mutual funds have deployed about Rs 2.2 trillion as on June'24, more than half which is via short term commercial paper. For NBFCs, asset liability management will become an issue if the delinquencies of unsecured loans rise. In November 2023, RBI, via a notification, increased the risk weights of consumer credit exposure of commercial banks and NBFCs (outstanding and new) for unsecured lending products. The increase of 25 percent points changed the risk weights to 125%. About 4 weeks prior to this notification, the RBI Governor had flagged “high growth in certain components of consumer credit advising banks and NBFCs to strengthen internal surveillance, address built-up of risks and institute safeguards”. The Governor had also highlighted the increasing dependence of NBFCs on bank borrowings during his interactions with the heads of major banks and large NBFCs in mid-2023.
Essentially, the two risks highlighted are
High growth in unsecured loans
High exposure of NBFCs in Banks’ loan book
In its notification, the central bank addressed 3 areas
Consumer Credit Exposure
Increase in the risk weight for credit exposure of commercial banks and NBFCs for personal/retail loans by 25 percent points to 125%
Increase in the risk weight for credit card receivables of commercial banks to 150% and of NBCS to 125%. The increase in both cases was by 25 percent points
Bank Credit to NBFCs
Increase in the risk weight on bank credit to NBFCs by 25 percent points where existing risk weight (per external rating of NBFCs) is below 100%
Strengthening credit standards
Limits to be prescribed for all unsecured consumer credit exposures with monitoring by the Risk Management Committee on an ongoing basis
Top-up loans on movable assets of depreciating value (vehicles) to be treated as unsecured loans
The Bank set 29 Feb 2024 as the last date for implementation.
The Back Story – Bank Credit
What prompted the RBI action? Have unsecured loans – credit cards and personal loans – grown out of proportion? The entire banking ecosystem is finely tuned. The interconnectedness is so extensive that a weakness in one area (segment / product / company) will spread creating a domino effect. Already, credit card balances have been increasing steadily. Personal loans, those not backed by physical / financial assets, have been keeping pace. The exposure of Banks to NBFCs - another risky area – has been rising steadily. Left unsaid in this communique was the other plays in the mix now – fintechs, lending aggregators and lending apps. While doing business only via regulated entities they are not regulated directly by the RBI, there by increasing the unease with procedures related to customer acquisition, underwriting, and risk management post onboarding.
As of March 2024, the total bank credit was in the tune of Rs 169 trillion. RBI helpfully publishes this metric along a few parameters. A few points stand out from the graphs I created using the RBI data
Both in terms of place of credit sanction and credit utilization, metropolitan areas account for more than 55% of formal credit; rural accounts for less than 10%
Average utilization (defined as ratio of outstanding amount to credit limit) is between 60% and 80% across interest rate range and credit limits. However, the utilization for the highest interest rate bucket (13% and above) is refreshingly below 13%. This is where most personal loans and credit cards lie.
Large accounts, defined as those with credit limit greater than Rs 2.0 lakhs, owe more than 90% of total outstanding at each interest rate bucket except for the highest (13% and above), where it hovers at 65%
We now look at the size of the problem.
The Back Story – Unsecured Personal Loans
RBI reports categorize personal loans into various segments including housing, advance against financial assets, education, credit cards, etc. As of May 2024, unsecured personal loans (loan against consumer durables, credit cards and other personal loans) stood at Rs 16.97 trillion. This segment now comprises more than 10% of overall bank credit. Since this is not backed by either physical or financial asset, the inherent riskiness of this segment is markedly higher than those of other secured personal loan products like housing, vehicle loan, loan against FD / jewelry etc.
While the total personal loan outstanding as on 31st May 2024 was Rs 54.6 trillion, unsecured products was more than a third of that.
Unsurprisingly, more than two thirds of both personal loan and bank credit is from urban and metropolitan areas.
The Back Story – Credit Cards
Credit cards have had a phenomenal run in the last two years (that I tracked) despite the growth and popularity of UPIs. Headline numbers: (1 trillion = 100,000 crore)
Outstanding balances = Rs 2.67 trillion (May’24)Spend (PoS + Online + ATM withdrawals) = Rs 1.65 trillion (May’24)Number of cards outstanding = 10.33 crores (May’24)Average spent per card = Rs 16,000 (May’24)Average outstanding balance per card = Rs 25,000 (May’24)
The year on year change in monthly balances – averaging ~30% in the last 2 years – is a cause of concern. It is noteworthy that the average spend per card per month has increased at 7.5% with average spent per card averaging around Rs 16,000. Customers seem to be revolving more with the average outstanding month-end balance increasing from Rs 20,000 per month to about Rs 26,000 in May.
The slight downward trend in y-o-y change in monthly outstanding balance seen from Nov 2023 may well be a function of larger base. However, with the festive season in Oct 2023 seeing the largest transactions in a month, it remains to be seen if the growth has peaked or is cyclical in nature.
Monthly spends by channel shows the increasing reach of digital transactions. The online channel now contributes more than 60% of monthly spends with the remaining coming from PoS (Point of Sale). ATM withdrawals which averaged around Rs 440 crore per month the last few months, constitute a very small portion of total credit card spends in a month. However, the amount is not insignificant by itself.
The other critical aspect is banks continue to issue fresh credit cards – the system has seen a net addition to the number of outstanding cards in the 24 months I analyzed.
The Back Story – Funding of NBFCs
Non-Banking Finance Companies (NBFCs), unlike a bank, are not permitted to accept demand deposits. As such, NBFCs depend on Banks and Mutual Funds for resources. The asset quality on the books of NBFCs therefore have a direct impact on the stability of Banks and Mutual Funds.
Deployment of funds by all Mutual Funds
Mutual funds deploy funds in NBFCs via two instruments – Commercial Papers (up to 1 year maturity) and Corporate Debt (Floating Rate Bonds, NCDs, etc.). Data published by SEBI shows as of June 2024, the total deployment stood at Rs 2.2 trillion, which is over 10% of total debt funds. Of this the short term commercial paper has seen a sharper growth and accounted for Rs 1.2 trillion. The two shortest maturity commercial papers – less than 90 days and 90 to 182 days account for more than 72% of the Rs 1.2 trillion commercial paper. Hence any weakness in NBFC risk management (that use these funds for lending purpose) may have a domino-like effect and impact the liquidity of debt mutual funds.
Even after RBI raised the risk weights in Nov’23, deployment by mutual funds kept a steady pace and in June 24, the y-o-y increase was 37% for commercial paper and 35% for corporate debt.
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Deployment of credit by all Banks
The total outstanding bank credit as on 31st May 2024 stood at Rs 168 trillion. The share of NBFCs, excluding housing finance companies (HFC) and public financial institutions (PFI) crossed Rs 1.0 trillion. As a percentage of overall bank credit, banks’ gross credit to NBFCs (excl HFC and PFI) continues to remain around 6 percent. The y-o-y growth in credit outstanding in June 23 was over 35% for NBFC excl HFC and PFI but settled around 18% the next 12 months. A longer period of monitoring would be essential to understand if the growth in this segment is outpacing the growth in total bank credit.
The Central Bank’s Concerns
Certain components of personal loans are, however, recording very high growth. These are being closely monitored by the Reserve Bank for any signs of incipient stress. Banks and NBFCs would be well advised to strengthen their internal surveillance mechanisms, address the build-up of risks, if any, and institute suitable safeguards in their own interest. The need of the hour is robust risk management and stronger underwriting standards. Governor’s Statement : Oct 6, 2023The concerns are to be limited to specific pockets. As I see from the data, the pockets are clearly identifiable. Any weakness in any of these 3 pockets would serve as an early warning system and could be contained without causing systemic risks. Much like a canary in a coal mine.
Growth in unsecured personal loan – Unsecured personal loans, including consumer durable loans, is the single largest category of all personal loans, right after home loans. In May 2024, unsecured personal loans (excluding credit card loans) comprised 8.54% of total non-food credit.
Growth in credit card issuances and online usage – Banks continue to issue credit cards at a steady rate. While there is no marked increase in average spending per card per month in the last few months, the balances have gone up, indicating more people may be revolving than paying the full outstanding. I couldn’t locate delinquency data to validate but stronger underwriting standards would be beneficial in order to have a robust credit card book.
Increase in funding from banks and mutual funds to NBFCs – Mutual funds deployed over Rs 2.2 trillion in NBFCs in May 2024, of which Rs 1.2 trillion was in the short term commercial paper. For banks, the % of total credit deployment has remained steady at around 6%. However, with bank credit itself increasing y-o-y, this deployment may be a cause for concern in case of any weakness in NBFC risk management and underwriting practices.
Impact of new regulations
Banks would need to evaluate their capital requirements which is expected to go up
This may lead to higher rates for borrowers
The transmission happened without much lag. In the last 6 months, most banks have raised their MCLR which determines the interest rate banks charged on various loans. It isn’t clear to me right now if this is enough or more needs to be done. However, as the Governor mentions, RBI is closely monitoring for any signs of incipient risk.
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