It was in September 2019 that the government instructed public sector banks to organise loan mela in as many as 400 districts to spur consumer loan growth. Four years later, things seem to have come full circle. Last week, the Reserve Bank of India cracked down on consumer lending, both by bank and non-banking financial institutions, through some macro-prudential measures.

Two key observations are hard to miss.

First, the RBI waited for Diwali to get over before announcing the measures that could force lenders to decelerate the margin-boosting retail loans.

Second, the RBI warnings on consumer loans growing above the trend line, first given at an NBFC meeting in September, and then in early October at the Monetary Policy Review, were merely a heads-up, not moral suasion, as is usually the chronology.

There is a third one, too.

The RBI is supplementing its interest-rate-hiking campaign to control inflation with macro-prudential measures.

Capital Charge

The RBI increased the risk weights on banks' old and new consumer credit, including personal loans but excluding housing loans, education loans, vehicle loans and loans secured by gold by 25 percentage points to 125⁒.

The same was also done for non-banking finance companies.

The risk weights for existing and new credit card receivables was raised to 150⁒.

The move came sooner than expected. The RBI did not even wait for a quarter to see how the trends unfold after it issued the warnings to banks against surging unsecured loans.

At its latest monetary policy review in October, Governor Shaktikanta Das warned that certain components of personal loans are recording sharp growth and that banks and NBFCs must strengthen their internal surveillance mechanisms to avoid built-up of risks.

Das had called for better underwriting standards from the lenders.

And before that, Das held a meeting with NBFCs and housing finance companies.

The RBI gave enough signals that the macroprudential measures were coming and then waited for the Diwali festivities to get over.

Banks will now be forced to earmark more capital to be able to lend. To that extent, they will be forced to prioritise industrial and farm loans over consumer and unsecured loans.

Raising capital in this environment is difficult, given the high-interest rates and volatile liquidity. The best option for banks would be to focus on big-ticket lending and investments in government bonds.

Retail Therapy

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.

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⁒.

The RBI has now sounded alarm.

According to 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 asset 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.

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.

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 even 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 to cater to the younger population. 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 spending, too, hit an all-time high of around ₹1.49 trillion in August.

Apart from the above trend in personal loan growth, the RBI is probably worried about the rising household indebtedness, especially among the young population.

As per RBI data, the net financial assets of 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.

Monetary Policy

The link between macroprudential measure and monetary policy is hard to miss.

It has been apparent that the central bank is looking at non-interest rate tools to contain inflation. First, the RBI began to operate on liquidity to force greater transmission of past interest rate hikes.

The RBI has raised the repo rate by 250 basis points to 6.5⁒ during 2022-23. It first imposed an incremental cash reserve ratio of 10⁒ to moderate liquidity and also said it would consider open market sale of government bonds, presumably after festival-related outflows return to the banking system.

Now, the higher risk weights could drive up some lending rates, which could be in keeping with the central bank's effort to keep its policy restrictive to keep inflation and inflationary expectations in check.

The RBI's latest move of increasing risk weights will ensure more diligent lending and help contain inflationary expectations.