A loan revolution is unfolding, but credit expansion can get better

Recently, the Reserve Bank of India raised the risk weight on unsecured consumer loans. The decision of the RBI is said to be driven by concerns about the fast growth in retail loans to individuals and bank lending to non–banking financial companies. Both of these put together contributed roughly half of the incremental credit in the past 12 months. This step, though considered as a tough measure, has received support from economists.

The 2008 financial crisis that emanated in the US, and gave the whole world jitters, is difficult to forget. The crisis had its roots in the highly liberal credit offerings and flouting of credit discipline by creditors as well as debtors.

The crisis remains a big lesson for financial regulators all over the world. The caution exercised by institutional lenders has proved to be right and we’ve not seen any repetition of the above situation. Our central bank, too, is cautious about the potential risks related to unsecured consumer loans and is wary of its negative consequences.

In half a century, the banking and financial scenario have completely changed in our country. Older people will remember how low the penetration of banking services was when they were young. Bank branches were few and far between and catered mostly to industrialists and big businesses.  

The nationalisation of banks in two phases, 1969 and 1980, was a game-changer for India. The expansion of the branch network in rural and far off areas, post nationalisation, allowed the poor and deprived people to get benefits from various government schemes implemented through these banks’ network. Regional Rural Banks (RRBs) have also made a significant contribution in promoting banking habits among rural masses. Financial inclusion is a national agenda and the country has made good strides in this.

Over the years, private banks’ network has also widely expanded. There is enough competition between banks to increase their market share in the retail loan segment, which includes housing, vehicle, education loan, loan against property and personal loan for various purposes such as marriage, tourism, purchase of consumer durables etc.

Considering the huge population of our country, comprising a significant middle-class, their growing aspirations and increasing income, retail loans offer tremendous opportunities for banks to earn by way of processing fee, interest income and other charges. Giving loans to a multitude of people distributes the risk and, thus, is less risky. When payment of loan instalments is tied up with salary, this mitigates the risk further.

In comparison, corporate credit carries a higher risk, including concentration risk. The retail loan portfolio has been contributing to a big chunk of banks’ income. The buoyancy we’re witnessing in real estate or the two- and four-wheeler market is a result of the retail loan revolution in the country.

Concerns of the RBI are genuine and, hopefully, lenders will take a cue from it. However, we shouldn’t forget the fact that globally debt plays a crucial role in driving economic growth.

For a long time, the debt market in India was mostly unorganised and, in the case of individuals, left to moneylenders and ‘sahukars’ spread in cities and villages. How such lenders overcharged interest and exploited their borrowers is known to all of us.

Access to institutional credit became possible much later. Though we see such lending institutions all around us, we don’t have to believe that every needy person has availed or can avail credit easily.

Considering the size of our economy, the country has enough headroom to expand its domestic debt segment covering individuals and enterprises. According to a World Bank report, India’s domestic credit to the private sector was 55% of its GDP in 2020, which is way below the world average of 148%. In comparison, it’s 182% for China, 165% for South Korea and 148% for Vietnam.

Debt has helped a large population to create assets, upgrade their living, engage in business and entrepreneurial activities etc.

By availing credit, farmers have been in a position to buy farm equipment, fertiliser and pesticide, resulting in better crop yields. In the absence of education loans, many bright students wouldn’t have been able to access higher education. Small loans to self-help groups in villages have transformed the lives of the members of these groups by engaging them in productive activities and keeping them away from social evils.

Wherever people have availed themselves of genuine credit and used it properly, they’ve benefited in a number of ways. Unfortunately, many frauds are happening in the credit space, which has kept banks on their toes.

There are defaulters, too, though, sometimes, the default in paying loan occurs due to reasons beyond the control of the borrower. In certain cases, banks also fail to exercise due diligence and fail in credit assessment. The cumulative effect of all this has been a huge rise in non-performing assets or NPAs. NPAs are a big headache for banks and managing them eats away much of their time.

For the regulator, being cautious is appreciable. At the same time, it has to ensure that the credit flow to the needy is not stopped. To reduce NPAs, banks have to be more careful at the pre-sanctioning stage and make use of analytics and artificial intelligence.

Credit adds to demand and consumption, resulting in more production and new employment opportunities. Needless to say, by bridging the credit gap and establishing a robust credit culture, India can further improve its GDP and other economic indicators.

(The author is a former banker)