The Reserve Bank of India (RBI) might increase the risk weights on unsecured personal loans and credit cards. This is because the RBI is worried that the high growth in these segments could lead to bad loans in the future.
Risk weights are percentages that adjust for the credit risk of different types of assets. A higher risk weight means that banks will have to set aside more capital to cover the potential losses on these loans. This will make it more expensive for banks to lend money, which could slow down the growth of these segments.
Unsecured personal loans are loans that are not backed by any collateral. This means that if the borrower defaults on the loan, the bank has no assets to seize to recover the money. Credit cards are also unsecured loans.
The RBI is concerned about the growth of unsecured personal loans and credit cards because these loans are more likely to go bad than secured loans. This is because borrowers who take out unsecured loans are more likely to be unable to repay them if they lose their job or have other financial problems.
Increasing the risk weights will limit banks’ ability to lend in the unsecured personal loans and credit card segments because it will require them to hold more capital. Currently, the risk weight for unsecured personal loans is 100% and for credit card debt, it is 125%. Risk weights are used to assess the credit risk associated with different types of assets. According to RBI data, unsecured personal loans have grown by 24% year-on-year as of April 21, 2023, compared to 18.2% growth in the previous year. Credit card debt has also increased by 29.7% year-on-year as of April 21, 2023, compared to 20.1% growth in the previous year.
If an unsecured personal loan defaults, banks may face a 100% loss. In the first year of non-payment, banks may provision 25%, but by the second year, they have to fully provision for the loan. Some banks even make a 100% provision in the first year itself for unsecured loans.
The RBI has not yet announced any changes to the risk weights on unsecured personal loans and credit cards. However, the agency has said that it is monitoring the situation closely.
Here are some additional details about the growth of unsecured personal loans and credit cards in India:
- Unsecured personal loans grew by 24% year-over-year (YoY) as of April 21, 2023.
- Credit card outstanding grew by 29.7% YoY as of April 21, 2023.
- Unsecured loans now make up 32.9% of the personal loans market.
- The RBI expects retail credit growth to remain robust in FY24.
A recent report by Care Ratings highlighted the strong growth of unsecured loans, including personal loans, credit card debt, and consumer durables, which grew by 25% year-on-year in April 2023. This growth can be attributed to the availability of credit, digitalization of loans, preference for high-end consumer products, and banks actively promoting credit.