UNSECURED RETAIL LENDING IN INDIA – CAPTURING EMERGING TRENDS

Abstract:

In recent times, RBI has been vocal about the high growth rate of unsecured retail credit in India as compared to the overall credit growth in the country. The RBI has termed the unsecured retail credit an “outlier segment” as far as its growth rate is concerned and has drawn the attention of banks and NBFCs in this regard. As part of regulatory intervention, RBI has also increased the risk weights associated with unsecured credit exposure of banks and NBFCs. Post this development, the banking fraternity has been divided in their understanding of the ground realities.  On one hand, there is a school of thought which feels that the recent surges in the unsecured retail lending in India is backed by solid macros. Whereas, others feel that the more than expected upsurge is a sign of incipient stress and might pose systemic risk, if not dealt with an iron hand.

Against this backdrop, this article delves upon the unsecured retail lending landscape in India. It tries to inform the reader about what constitutes unsecured lending, the various products and the size of this market. It also touches upon the apprehensions of RBI regarding the high credit growth in general. A discussion is made regarding the following 4 key concern areas of RBI viz.   Sustainability of Growth, Unsurious Pricing of loans by NBFC-MFIs,Over-reliance on Analytics and increasing interconnectedness  of Bank –NBFC linkages.

Furthermore, in trying to capture the emerging trends in the unsecured retail banking space, the article explores the evolution of digital finance and the contribution of fin-techs in the recent lending binge. Besides, it also underscores the role of embedded credit products in developing an ecosystem for providing appropriate and timely credit delivery. The discussion revolves around the rising culture of credit driven consumption among the young population of India (the digital natives) and its impact on the growth of unsecured retail credit market in India.

Introduction:-

Back in August 2023, the Reserve Bank of India (RBI) Governor Shri Shaktikanta Das during his interaction with the heads of major commercial banks and large NBFCs, flagged the issue of high growth in certain segments of consumer credit and an increase in dependency of NBFCs on bank borrowings. The same was followed by the November 16 notification of RBI wherein the Risk Weights (RW) on consumer credit exposure of commercial banks was enhanced by 25 % (from 100% to 125%). However, Housing Loan, Education Loans, Vehicle Loans and Loans secured by Gold and Gold Jewellery were kept out of the ambit of this enhanced RW. Risk Weights on Credit Card receivables of SCB’s, which till now attracted a RW of 125%, were also enhanced to 150%.

Post this development, the banking fraternity has been divided in their understanding of the ground realities.  On one hand, there is a school of thought which feels that the recent surges in the unsecured retail lending in India is backed by solid macros. Whereas others feel that the more than expected upsurge is a sign of incipient stress and might pose systemic risk, if not dealt with an iron hand.

Against this backdrop, this article attempts to capture the broad trends in the unsecured retail lending market of India.

 

What Constitutes Unsecured Retail Lending?

Banks and Financial institutions lend money to individual borrowers to cater to diverse needs. In some cases, the financial institutions obtain an underlying security for securing the loan. These types of loans are called secured loans. However, in many cases, borrowers are not required to provide any collateral security to the bank to avail loans. Loans are disbursed to the borrower primarily based on the credit history of the borrower and the lenders assessment of the ability of the prospective borrower to repay the loan. These categories of loans are referred to as Unsecured Loans. Credit worthiness, income and the employment history of the individual plays a crucial role in the assessment of such loans.

Some of the most common types of Unsecured Retail Loans in India are as follows:

1. Personal Loans – As the name suggests, proceeds of this loan can be utilized by the borrower for incurring any kind of personal expense like weddings, travel, medical emergencies, etc. There are no stipulations from the lenders side regarding the end use of funds.
2. Overdrafts on Salary Accounts –These are short term unsecured loans given to individuals maintaining salary accounts with the lender. These loans are designed to tide over temporary cash flow mismatches of the salary holder. The application and approval process is quite easy. The loan eligibility is often quantified in terms of the number of times of monthly salary of the applicant. Many fin techs and NBFCs are also market this product as Pay day Loans.
3. Credit Card Receivables -Credit card holders are provided with credit limits and cash withdrawal limits. Card holders can make purchases from physical stores or make e-commerce transactions up to the credit limit set by the issuer.  Grace periods of 50-60 days are given to the borrower to repay the amount. Beyond that interest is charged on the outstanding amount.
4. Consumer Durable Loans –It is a category of consumption loan wherein the proceeds are used for purchase of some consumer durable goods, like Household appliances and electronic gadgets etc. Loan to the extent of 100% of price of the article is provided. In most cases the repayment is done in installments and the borrower can repay over a period.

Unsecured retail loans are important in providing timely financial support to individuals and provide borrowers with unmatched flexibility in terms of the end use of funds and repayment schedule, ease of assessment and simplified documentation.

Unsecured Retail Credit Market in India:-

The retail credit industry has been growing at a phenomenal pace. As per estimates by CIBIL, in the last 5 years, the industry has grown from Rs 51.33 Trillion in FY 2018-19 to Rs 88.01 Trillion in FY 2022-23 at a CAGR of above 14%.  Given below is the snapshot of the Retail lending portfolio as on 31/03/2023.

Secured Retail loans (other than the business loans) comprises of the Housing loans, loans against FD, loans against shares & bonds, vehicle loan, Loan against Property (LAP) and gold loans. The remaining portfolio of Personal Loans, Consumer Durables Loans and Credit Card Receivables comprises of the unsecured retail credit market. Unsecured Retail Credit segment has been growing the fastest in recent times as exhibited below:

RBI Apprehension

RBI has observed that, in the last 2 years, unsecured retail credit has been an outlier segment as far as its growth rate is concerned. This category of loan has spiked 23 per cent against an overall credit growth of 12-14 per cent only. Unsecured loans, though small in size, can pose systemic risk if their growth remains unchecked. Hence, RBI has termed its regulatory intervention as “a pre-emptive measure to bring certain prudence and to bring an end to any sort of exuberance that may be exhibited by certain lenders”. In this regard, RBI Governor has underscored 4 key concern areas related to credit growth:

1. Sustainability of Growth – The RBI governor stressed on the need for Banks and NBFCs to be mindful that credit growth at the overall, sectoral and sub-sectoral levels remains sustainable. To that end, banks and NBFCs to ensure that the expansion of credit portfolio and pricing should be appropriate to the risk involved, and they should strive to further strengthen their asset liability management.
2. Unsurious Pricing of loans by NBFC-MFIs – The RBI Governor has pointed out to the fact that certain NBFCs-MFIs appears to be enjoying “relatively high interest margins”. As these financial entities often cater to the marginalized clientele, they are expected to ensure that interest rates are transparent and not usurious. Affordability and repayment capacity of their borrowers to be kept in mind while fixation of interest rates. This, in turn, will ensure that the assets do not get stressed later.
3. Over reliance on Analytics – While praising the digital technologies and resultant innovative business models introduced by the collaboration between banks/NBFCs and fintech, the governor cautioned regarding the over reliance on “model-based lending through analytics”. Banks and NBFCs need to be careful in depending only on “pre-set algorithms as assumptions based on which the models are operated”. He stressed on the need for periodic testing of the models and recalibrating the models from time to time based on “changing contours of the financial ecosystem and fresh information”. He advised the Banks and NBFCs to be more watchful of any information gaps in these models, which may cause dilution of underwriting standards.
4. Bank –NBFC linkages – Commenting on the increase in borrowings of NBFCs from Banks, the governor asked the stakeholders to be mindful of the increasing inter connectedness between banks and NBFCs to avoid any sort of contagion risk. He advised the banks to constantly evaluate their exposure to NBFCs and the exposure of individual NBFCs to multiple banks. The NBFCs were advised to focus on “broad basing their funding sources and reducing over-dependence on bank funding”.

To sum up, RBI wants the credit growth to be sustainable and intends the financial institutions to formulate their business models in a manner in which an avoidable risk buildup is mitigated.­­

Impact of the move: What RBI wants to achieve?

Increase in Risk Weights will result in banks and NBFC allocating more capital against the unsecured loans they disburse. A point to note here is that the new regulation will also be applicable to outstanding consumer credit portfolios (excluding housing loans, education loans, vehicle loans and gold loans) of commercial banks and NBFCs. Hence, the players having large proportion of exposure to consumer credit will be impacted more.

Increase in capital allocation will entail capital costs. Hence, the lenders have 2 options: a) Raising the interest rates on unsecured lending b) Reduction in exposure to unsecured loans and focus on segments which consume less capital. Both these moves, in a way, will bring in what the RBI intends; moderation in the growth of unsecured loans.

Recent Trends in Unsecured Retail Lending in India

Evolution of Digital Finance – Role of Fintechs 

The period 2019-2023 has seen the maturing of the Indian Fin-tech Ecosystem. India is currently the 3^rd largest fin tech ecosystem globally (1st –USA and 2^nd –United Kingdom) with 1500 plus Fin techs (450 plus in Lending Tech). These fin techs have a “Digital First” approach in its business and operation. Due to their strong grip over technology; they have been successful in providing a differentiated experience across the customer lifecycle. During the COVID years, the Indian government has taken many initiatives for digitalization of the economy facilitating the growth of the fin tech lenders.  Post –Covid unlocking, they have also focused on penetrating their reach in the un-served and underserved market. As per CIBIL data, the share of loan origination of fin techs from Semi Urban and Rural areas have improved from a modest  36% in FY 2018-19 to 51% in FY 2022-23 . ­­­As a result, Fin-Tech Lenders have evolved from a largely urban to a geographically well diversified play in just 5 Years.

Basis CIBIL, Indian Fin techs have originated 79 million loans amounting Rs 1107 Billion in FY 2022-23.

As is seen above, the bulk (75.45%) of the loan origination is in the Personal and Consumer loan category which cater to the consumption needs of the borrowers.   Consumption Loans origination by Indian Fin Techs has risen from Rs 0.07 trillion in FY 2018-19 to 0.84 trillion in FY 2022-23 at an impressive CAGR of around 98%.

Fin Techs are appealing first time loan takers or what is referred to “New to Credit” (NTC) borrowers due to their simplified underwriting procedures and convenience of on boarding. As per study conducted by CIBIL, Fin Tech lenders have on boarded 7.3 million NTC customers in FY 2022-23 (up from 125 million in FY 2018-19).

However, in their pursuit for aggressive growth, fin tech players have often been criticized for their overtly simplified Underwriting methods and resultant dilution of lending standards.

Youthful demography – Aspirational Young Middle Class and Rising confidence level.

Indian economy is in the midst of a demographic dividend. The median age of India is 28.4 years. This young population is not only a source of India’s competitive advantage, but also defines the consumption power of a young population towards discretionary expenditure. The young population of India, especially the millennial and Gen Z population (part of the digital natives) are gradually opening up to credit driven consumption. The formalization of the economy through digitalization of payment system provides an avenue for better credit assessment of the citizens who in the past may not have been eligible for consumer loans.  As the digital natives are having a strong visibility of future earnings, there is an increasing confidence to borrow. Large sections of the youth are taking loans for discretionary spends like theme-based destination weddings, foreign travels etc to fulfill aspirations and live life to the fullest. This trend of financing current consumption not just with current income but also with a part of future income, in turn, is   fuelling the growth story of unsecured retail lending in India.

 Advent of Embedded Credit.

Embedded banking refers to the integration of banking/ financial services or tools within the products or services of a customer facing non-financial organization. When the banking product is of the nature of credit facilities, it becomes embedded credit. For example, a customer purchasing a laptop on an e-commerce site can convert her purchase into EMI of 12 months tenure without having to go to any website of a Bank/NBFC. The entire loan journey is ingrained within the digital platform of the e-commerce site (non-financial organization) and the process gets completed within a span of few minutes. This process also helps the bank/NBFC partner to get access to new datasets around the customer from the nonfinancial organization. Banks are capitalizing on this through targeted analytics strategies to customize product offerings.

Some examples of embedded credits are:

1. Embedded credit options at bill payment desks at Hospitals for patients to cover medical expenses.
2. A Preapproved Buy Now, Pay Later (BNPL) product at e-Commerce sites/ Car Dealerships (for purchase of accessories).
3. BNPL products while purchasing a Movie on a smart TV
4. Co-branded Credit Cards

This concept has gained popularity in India and credit is getting embedded in almost all the products and services which customers are expected to avail. This, in turn, is driving the growth of unsecured retail credit.

Conclusion 

RBI’s move to increase the Risk Weights on consumer lending has alerted the industry to be more mindful while giving unsecured lending. It is more of an advisory to the regulated entities to ramp up their systems and processes of appraising and disbursing unsecured loans.  The move has made some NBFCs/fin tech players to introspect on the pace of growth of disbursing personal loans in the short term.

However, to a larger extent, the increase in demand is a reflection of a changing society where earlier loans was considered a taboo and today, people are open to taking credit. Hence, the growing demands for unsecured loans primarily due to the trends discussed above are more structural in nature and will remain intact.

 The need of the hour is consistent investment in technology and use of data and analytics. This will ensure further strengthening the underwriting and risk monitoring capabilities of all participants in the retail credit industry. This will ensure that all avoidable risk buildup is mitigated and usher in an era of sustainable credit growth.