RBI's Renewed Interest in Unsecured Lending

India has seen unprecedented credit growth in unsecured retail lending. According to the Reserve Bank of India (RBI), as of December 2021, the year-on-year (YoY) growth rate of bank credit in India was 5.9%. However, unsecured lending has shown tremendous growth. India’s unsecured retail lending market has grown at an impressive 25% CAGR over the past three years, with an increasing focus on the semi-urban regions of Indian customers.

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Why Is the RBI Worried About Unprecedented Growth in Unsecured Lending?

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“In the eyes of RBI, unsecured matters are akin to playing with fire.”

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What pinched RBI is unsecured and the current model. The typical unsecured lending works in the following way:

• Borrowers apply for unsecured loans without collateral from banks, NBFCs, or online platforms
• Lenders assess applicants based on credit scores, income, and employment.
• Approved loans are disbursed for various needs such as personal expenses, education, or emergencies
• Repayment involves fixed installments covering the principal amount and higher interest rates
• Interest rates are determined based on credit history, risk assessment, and market conditions
• Unsecured lending poses higher risks to lenders as there's no collateral to recover funds in case of default
• Defaulting on payments may lead to legal action, but recovery without collateral is challenging for lenders

The Current Default in Unsecured Lending

Non-performing assets (NPAs) in the category of loans valued at less than ₹50,000 have surged to 5.4% as of June 2023, a sharp increase from 4.2% a year ago. The number of individuals with multiple loans in this category has also notably increased.

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Delinquencies have surged notably in loans valued at less than ₹50,000. Larger-sized loans, above ₹8 lakh, demonstrate more stability and controlled delinquencies.

Preventing the Bubble From Bursting: New Risk-Weighted Asset Rating for Unsecured Loan

The RBI's recent measures to address the surge in unsecured loans and NPAs involve a significant increase in risk weights for consumer credit. Notably, the risk weight for unsecured personal loans has been raised by 25 percentage points to 125%. The move comes amidst staggering statistics revealing a 23% growth in unsecured credit over the past couple of years, surpassing the growth of other lending categories at 12-14%.

What Does It Mean?

By elevating risk weights, such as from 100% to 125% for consumer loans, the RBI aims to reinforce prudential norms and enhance the resilience of financial institutions against potential losses from defaults in unsecured lending. This move may lead to a significant rise in the cost of financing for unsecured loans, potentially making borrowing 25% more expensive for consumers. It also underscores the RBI's commitment to maintaining a robust and stable financial system by ensuring lenders exercise caution and prudence in their lending practices to mitigate risks associated with unsecured credit.

Growth is Not Only the Concern, Governance Plays Its Part Too

The Reserve Bank of India (RBI) stands deeply concerned about the governance practices adopted by lenders in the realm of unsecured lending. The recent imposition of a ban on two key unsecured products offered by Bajaj Finance serves as a stark testament to the RBI's apprehensions surrounding this domain. Let’s look into what has transpired recently with Bajaj Finance.

RBI's Restrictions on Bajaj Finance

The Reserve Bank of India (RBI) imposed constraints on Bajaj Finance, a significant non-banking finance company (NBFC), instructing it to halt lending operations related to two vital products: 'eCOM' and 'Insta EMI Card.' As a result, Bajaj Finance's shares plummeted by 3.97% to ₹6,937.15 in early trading on the Bombay Stock Exchange (BSE) following the RBI's directive.

RBI's Concerns and Analyst Viewpoints

Expressing apprehensions about the non-dissemination of Key Fact Statements (KFS) to borrowers regarding these loan products, the RBI’s restrictions are seen by analysts as more of an operational lapse than a severe breach. They anticipate a short-term impact on Bajaj Finance shares, with CLSA predicting a 6% profit impact during the embargo period.

Immediate Impact and Response

Bajaj Finance's 'eCOM' lending, primarily on popular e-commerce platforms like Amazon, Flipkart, Yatra, and MakeMyTrip, was immediately affected by the RBI's directive. Disruption ensued for existing EMI cardholders' purchase financing through these platforms. Responding to the RBI's directive, Bajaj Finance pledged a thorough review of KFS and committed to taking prompt corrective actions, emphasizing its compliance with regulations.

Analyst Perspectives and Financial Performance

Various financial analysts hold distinct perspectives on the situation. Jefferies forecasts a limited financial impact, while Morgan Stanley foresees no substantial financial repercussions. CLSA expects a 6% profit impact during the ban period, while Citi adopts a "neutral" stance.

Bajaj Finance reported a robust second-quarter fiscal year 2024 (FY24) performance, marked by a 27.8% surge in net profit, reaching ₹3,550.8 crore, and a 26.3% increase in net interest income (NII) to ₹8,845 crore. The NBFC experienced improvements in gross and net non-performing assets (NPAs) and observed a surge in loans booked, deposits, liquidity surplus, and assets under management (AUM).

Navigating Potential Changes in Lending of Unsecured Lending Amidst RBI Actions

Rates

We can potentially see an upward movement of 25 basis points or more in the interest rates as the unsecured loan becomes dearer to the lenders. The lending institutions now have to reserve more cash as a buffer in case of default which otherwise would have been lent as loan.

Lenders

The RBI increased the capital buffer that banks are required to set aside. This means that for every loan, lenders need to deposit some money with the RBI so that if a customer defaults, the bank has some funds to repay its depositors.

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Now, lenders have fewer funds available for lending because they are required to keep more money with the RBI. As a result, lenders will earn less interest income on loans.

Fintech Players

Fintech platforms may experience an increase in their cost of borrowing from traditional financial institutions. Banks might pass on the higher costs due to increased capital buffers by charging higher interest rates on the funds lent to fintech platforms.

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This could result in fintech companies having to charge higher interest rates on their loans to maintain their margins, potentially making borrowing more expensive for their customers.

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