The Reserve Bank of India (RBI), India’s central bank, has recently taken a significant step to address the alarming growth of unsecured personal loans by increasing the capital requirement for banks and non-banking financial companies (NBFCs). This move comes after years of ignoring warning signs of rising delinquencies in this segment.
Collapse of Large industrial credit
The real growth in an economy is built on bank credit to large industries and infrastructure projects. This segment, which saw a big boom during the Congress-led United Progressive Alliance (UPA) government, witnessed a tepid growth of 2.96 per cent in the first term of the Narendra Modi government (from Rs 20.44 trillion in 2013-2014 to Rs 23.65 trillion in 2018-2019).
Inflation will continue to give RBI sleepless nights. In the first three years of the second term, credit to this segment collapsed recording a paltry growth of 0.46 per cent per annum. The situation improved a little thereafter, and outstanding credit reached Rs 25.8 trillion on September 22, 2023.
Still, for the four-and-a-half-year period of the second term, the large industry and infrastructure credit growth has been less than 2 per cent.
Unsecured Personal Loans: A Growing Concern
Unsecured personal loans, which are not backed by any collateral, have witnessed a meteoric rise in recent years. This growth has been fueled by factors such as easy credit availability, aggressive marketing by NBFCs, and a growing consumerist culture.
The rapid expansion of unsecured personal loans has raised concerns among policymakers, as it poses a potential risk to the banking sector. The RBI, in particular, has been closely monitoring the situation and has expressed concerns about the potential for a surge in non-performing assets (NPAs) in this segment.
The RBI’s Response: Increasing Capital Requirements
The RBI’s decision to increase capital requirements for unsecured personal loans is aimed at forcing banks and NBFCs to slow down the growth of these loans or hold more capital to cover potential losses. This is expected to make these loans more expensive for borrowers, which may help to dampen demand.
The RBI’s move is a significant one, as it signals a departure from the previous policy of allowing banks and NBFCs to lend freely to this segment. The central bank’s decision is likely to have a ripple effect on the unsecured personal loan market, which has grown accustomed to easy credit availability.
The Impact on Banks and NBFCs
The RBI’s decision to increase capital requirements is likely to have a significant impact on banks and NBFCs. Banks will need to set aside more capital to cover their exposure to unsecured personal loans, which will reduce their ability to lend to other sectors. NBFCs, which have been particularly aggressive in lending to this segment, will also be affected by the increased capital requirements.
The impact on banks and NBFCs is likely to vary depending on their individual risk profiles. Banks with a higher proportion of unsecured personal loans on their books will be more affected than those with a more diversified portfolio. NBFCs, which are generally more reliant on wholesale funding, will also face additional challenges in meeting the increased capital requirements.
The Implications for Borrowers
Borrowers are likely to face higher interest rates for unsecured personal loans as a result of the RBI’s move. This is because banks and NBFCs will need to pass on the increased cost of capital to borrowers in the form of higher interest rates.
The higher interest rates may discourage some borrowers from taking out unsecured personal loans. This could lead to a slowdown in the growth of this segment, which has been a major driver of consumer spending in recent years.
The Long-Term Outlook
The RBI’s move to increase capital requirements for unsecured personal loans is a necessary step to address the growing risks in this segment. However, it is important to note that this is just one step in a broader effort to restore a risk-based credit culture in the banking sector.
The RBI and the government will need to work together to address the structural issues that have led to the current situation, such as the overemphasis on personal and MSME lending and the regulatory forbearance that has encouraged banks to lend more aggressively to these segments.
Only by addressing these underlying issues can the RBI and the government ensure that the banking sector is resilient to future shocks and that credit is allocated efficiently to support sustainable growth in the Indian economy.