Implications of tighter norms for unsecured loans in Indian financial sector: IIFL Capital Services

16 Jun 2023 , 11:18 AM

Runaway growth in unsecured retail loans (26% YoY vs 15% for total loans in FY23) has been the key concern of investors and the RBI. These loans constitute 9% of total system credit, but contributed 17% to incremental growth in FY23. Recent media reports suggest that the RBI may increase risk weight on personal loans and credit cards. Analysts of IIFL Capital Services estimate 10-70 bps capital impact for banks and 10-220 bps for the NBFCs (if made applicable to the NBFCs too). Though the impact is lower at 10- 30 bps for PSU banks, some of them may need to raise capital, factoring in the potential ECL impact and need for growth capital. The first order impact would be growth slowdown in these loans, which would impact margins as well. Analysts of IIFL Capital Services would be more worried about the asset quality of lenders with FinTech sourcing models (weaker underwriting) and those catering to NTB/NTC customers. This should also weigh on valuations of select NBFCs that have witnessed meaningful re-rating, on the back of strong growth in unsecured personal loans. 

Why is strong unsecured retail loan growth a concern?

The BIS data shows that household credit-to-GDP ratio for India has declined from 42% in 2008 to 36% in 2022. On the other hand, it has gone up by 5-45pp to 50-95% for other Asian countries during this period. Even personal-loan penetration for India is lower at 7% of private final consumption expenditure (PFCE) vs 10-45% for other countries. Thus, on a top-down basis, there seems to be an absence of exuberance in India’s retail loans. 

However, analysts of IIFL Capital Services believe that the cause of concern is the strong pace of growth in unsecured retail loans (personal loans, credit cards and consumer durables considered for the purpose of discussion) in recent times. As Figure 3 shows, these loans grew 20-65% for Private banks, 25-60% for Public banks and 26%-to-8x for select NBFCs (from lower base). At the system level, banks grew these loans by 26% in FY23 (vs overall loan growth of 15%) and NBFCs by 13% HoH (vs overall loan growth of 1%, as of H1FY23).
 

What is the exposure of lenders to unsecured personal loans and credit cards?

• At system level: Personal loans, consumer durables and credit card portfolio for banks + NBFCs at the system level is around US$200bn. Banks have 82% market share within this pie and NBFCs have around 18%. Together, these loans constitute 10% of total system loans, with personal loans being 8%, credit card 1.5% and consumer durable 0.5% of total loans.
• At individual lenders’ level: In terms of share of total outstanding loans, it is 5-25% for Pvt bank, 2-11% for PSU banks and 2-37% for NBFCs. However, contribution of these unsecured loans to incremental overall loan growth in FY23 was even higher across lenders

How to think about implications of potentially tighter regulatory norms?

1. Slowdown in loan growth: 

Analysts of IIFL Capital Services believe that the first order impact would be seen in the loan-growth slowdown in these segments. The advent of newer sourcing methods (ala FinTech partnerships) and improved data availability (ala Account Aggregator framework) has led to a spurt in small-ticket personal loan volumes, and has resulted in expansion of the overall market. Sustained strong growth in profitable segments eventually results in impacting unit-economics or creating asset quality issues.

2. NIM contraction: 

Loan re-pricing has largely happened (except for MCLR-linked loans), but the funding cost is still going to rise higher. In this backdrop, if incremental growth from higher-yielding unsecured loan products decelerates, lenders could see higher-than-expected NIM contraction.

3. Asset quality risk: 

At the system level, share of 30+ DPD loans in personal loan (ex CC) at levels of 6% was still higher by 200 bps vs pre-Covid. More importantly, delinquencies for new-to credit (NTC) customers who often avail small-ticket personal loans, is 75-90% higher than non-BNPL category of customers. Lenders driving this growth via FinTech partnerships (weaker underwriting) and by catering to NTB/NTC customers (like AB Capital, Poonawala, Piramal, IDFC FB) — are of particular concern. Even HDBK is now going to launch personal loans for NTB customers. On the other hand, lenders doing more of cross-selling or lending to lower-risk profile of customers should be less impacted (BAF and SBI have <1% NPAs).

4. Impact on capital if risk weights increase for personal loans: 

Current risk weights for personal loans and credit cards is 100% and 125% respectively. The RBI had cut risk weights on personal loans from 125% to 100% in Sep’19 for banks. Therefore, analysts of IIFL Capital Services expect that increase in risk-weight, if any, would mainly be for unsecured personal loans to perhaps 125% (and not for credit cards). Historically, RBI has not tempered with risk weights for NBFCs (no change in Sep’19); hence, one can possibly argue that risk-weight increase, if any, could only be for banks. However, for the sake of their sensitivity analysis, analysts of IIFL Capital Services assume that risk weights will move up even for the NBFCs (as some of them grew very strongly in the last few quarters). Analysts of IIFL Capital Services are also unclear as to whether higher risk-weights would be applicable only for incremental loans or on the entire stock of outstanding unsecured loans.