On average, I receive five calls daily from banks’ agents offering personal or business loans, but one particular product surprised me the most.

The lady caller on the line offered a personal loan against my 13-year-old car. When I heard her out and politely refused, she snapped as to why I did not cut the call then and there and instead made her complete the pitch. Probably, she had to make many more calls to potential customers, and the time she spent speaking to me was one minute too many.

But this essay is not about pesky calls or curt responses.

The point to ponder is: are banks and non-banking finance companies going too far with retail loans and unsecured personal loans?

Against the backdrop of the recent bank failures in the US and also troubles with real-estate companies in China, are Indian banks building up a retail bubble that endangers India’s financial stability and, eventually, economic growth?

There are many reasons why retail and unsecured loans are booming in the current credit cycle. But before that, some numbers:

Retail loans have grown at a compounded annual growth rate of 25% from March 2021 to March 2023, almost double the CAGR of 14% for gross loans during the same period, as per data from the Reserve Bank of India’s latest financial stability report. Retail loans formed around one-third of the total banking system’s gross loans and advances.

Credit growth of banks in 2022-23 was at 15.4%, which is a decade high. This was due to pent-up demand post-pandemic and also high nominal growth in GDP. Private sector banks appeared to be catching up on lost time, if any.

There is a change within the retail loan mix as well. The composition of unsecured retail loans has risen from 22.9% to 25.2%, and secured loans fell from 77.1% to 74.8%.

The RBI has taken notice but has not sounded any alarm yet.

According to the RBI data, the gross bad loans in retail lending were low at 1.4% in March 2023, but the share of special mention accounts--which indicates high proximity to default--was relatively high at 7.4% and accounted for a tenth of the retail assets portfolio of PSU banks.

Unsecured retail loans formed 7.9% of the total banking system credit. Their asset quality has improved, with the gross bad loan ratio contracting from 3.2% to 2.0% during this period, according to the RBI’s latest Financial Stability Report.

Governor Shaktikanta Das held a meeting recently with big NBFCs and housing finance companies. Ways to contain the increasing reliance on bank borrowings, risks associated with high credit growth in the retail segment, and prioritising the upgrade of IT systems and cyber security were discussed, according to an RBI statement regarding the meeting.

Watchful, Not Alarmed

Banks’ risk appetite has grown significantly as the business environment has improved post-COVID and also as banks’ capital buffers have been strengthened due to capital infusion from the government in several PSU banks and also from their earnings.

Banks’ operating profits are equivalent to around 2.8% of risk-weighted assets in FY23, up from 0.6% in FY20, according to an estimate by rating agency Fitch.

Capital buffers and improved risk appetite are prompting banks to go for better margins offered in retail and personal loans. Moreover, stiff competition is forcing banks to stretch themselves, which probably includes offering loans against old cars.

Banks’ exposure to NBFCs has risen 35.1% on-year to ₹14.2 lakh crore as of June 2023, as per the latest RBI data. In turn, NBFCs’ share in overall bank credit increased to 9.9% from 8.5% a year ago. To that extent, banks’ indirect exposure to retail, including unsecured loans, has risen.

Demographics, too, are playing their part, encouraging banks to take more risks. Post-COVID, there is a surge in travel and purchases of durable goods and also housing. Innovative schemes like buy now and pay later and deferred EMIs have generated significant demand for bank loans.

Credit Card spends are at an all-time high of 1.49 trillion rupees

At a recent speech, RBI Deputy Governor Michael Patra, who is in charge of monetary policy, acknowledged that the current episode of bank credit expansion is led by retail loans.

“We are, however, watchful as herding by banks in the retail loan space might lead to potential cascades across the system if defaults do occur”.

Debt Burden

The sharp fall in India's household savings is also telling. As per RBI data, the net financial assets for households have fallen to 5.1% of GDP in 2022-23 from 7.2% in 2021-22 and from 11.5% in 2020-21.

The fall was mainly due to a rise in financial liabilities or loans in relation to financial assets like deposits, provident funds, or some insurance products. At 5.1% of GDP for 2022-23, net financial assets were at a 23-year low.

A finance ministry statement made light of the data, saying it reflects the changing consumer preferences for different financial products.

"The household sector is not in distress. They are buying vehicles and homes on mortgages.”

Another question is if all the banks are herding for retail loans, who would fund the burgeoning need to fund infrastructure?

The share of large borrowers in gross advances of banks declined successively over the past three years, from 51% in March 2020 to 46% in March 2023, as retail loans grew faster than borrowings by corporates.

The share of large borrowers in banks’ gross loans also came down from 76% in March 2020 to 54% in March 2023.

Banks, probably, are still smarting from the troubles they faced in the aftermath of the global financial crisis when they lent massively to support infrastructure and heavy industry investment.

On the premise that infrastructure involves long gestations, bank loans were allowed to be restructured while treating them as standard advances in banks’ books with insufficient provisioning.

But Asset Quality Review undertaken by the RBI showed poor quality of assets, forcing heavy provisioning and capital infusion. Several banks were placed under prompt corrective action, which restricted their activities.

An important aspect discussed by Governor Das at his meeting with the NBFCs was increasing reliance on bank borrowing. While that related to bank lending to NBFCs, the broader question is how long the RBI will allow an unrestricted run in growing indebtedness of households.

The next MPC review in October could see the RBI throwing more colour on the issue.