Intensifying Stress In Unsecured Lending Puts Banks On Watch

Even though the share of unsecured loan portfolio is miniscule at most banks and non-banking financial companies, the rising stress in the segment has caught everyone's attention.

The Reserve Bank of India, in its latest monetary policy review, warned of risks arising from the personal loan segment, which are largely unsecured loans. The central bank implored banks to assess their risk strategies on their personal loan exposures. 

"Certain components of personal loans are, however, recording very high growth. These are being closely monitored by the Reserve Bank for any signs of incipient stress," Governor Shaktikanta Das said, during his monetary policy speech.

It is no surprise that banks and NBFCs have ramped up commentary on rising delinquencies in their personal loan portfolio for the quarter ended September.

Small-ticket personal loans, amounting to less than Rs 50,000, accounted for only 2% of banks' overall personal loan book size as of FY23, SBI Research said in a report dated Oct. 20.

According to RBI data, unsecured personal loans disbursed by banks rose to Rs 12.20 lakh crore as of Aug. 28, up 26% year-on-year.

Banks Tiptoeing Around Unsecured Loans

ICICI Bank Ltd.'s personal loan portfolio, which accounts for 9.2% of the total loan book as of Sep. 30, grew 40.4% year-on-year to Rs 74,355 crore. The management, in its post-earnings call, said that any rise in delinquencies in the personal loan portfolio would have implications on other segments as well.

"As far as our portfolio is concerned, we have a very minimal presence in the smaller ticket size segment," Anindya Banerjee, group chief financial officer of ICICI Bank, told analysts. "...we feel that the risks should not be something which should cause too much concern. But we will continue to monitor this as we go along."

Banerjee said that a strong credit demand has helped personal loan portfolio maintain its profitability. "Otherwise, we can always prune it if required," he said.

Similarly, consumer financier Bajaj Finance Ltd. has curbed its exposure to urban unsecured retail loans by 8% and rural unsecured loans by 14%. The NBFC also signalled a moderation in the segment going forward.

Yes Bank Ltd. also concurred. The private lender's Chief Executive Officer Prashant Kumar highlighted "a slight deterioration" in the unsecured loan segment where the repayment remains outstanding beyond 30 days since due date. Personal loans comprised 16% of the bank's overall retail book as of Sept. 30.

"Size of delinquencies are on the increasing trend on unsecured loans. Overall, there are concerns, but not in a significant way. It is a function of how strong are the collections and efforts put into collections," Kumar said.

The bank, however, is strategically going slower in certain retail segments such as unsecured loans, Kumar said.

A relatively low personal loan exposure indicates "contained risk at the time", noted SBI Research.

Kotak Mahindra Bank Ltd., despite higher delinquencies from last year, does not see a need to "put the brakes or start panicking", Dipak Gupta, interim managing director and chief executive officer of the bank, said in the media briefing. But, the small-ticket loans segment is something to watch out for, Gupta added.

Further, Axis Bank Ltd.'s Sumit Bali, group executive and head-retail lending, expects the delinquencies to rise in retail loans that fall in the below Rs 50,000 bracket. While the private lender has "stayed away from" the segment, Bali said that "delinquencies are distorting the views across the unsecured loan segment".

Amitabh Chaudhry, managing director and chief executive officer at Axis Bank, said that the lender is not seeing any rise in risk in its unsecured lending portfolio. "We continue to grow our personal loan portfolio based on the risk guard rails. The growth is not coming at the cost of what we believe (is the) kind of risk to take," Chaudhry said.

The Way Ahead

As the share of unsecured personal loans has more than doubled in the past five years, it comes with a bag full of risks for lenders.

Borrowers have been stacking up personal loans without repaying previous debts, which may elevate the delinquency levels for banks. Moreover, multiple small-ticket loans of below Rs 20,000 to purchase consumer durables could have larger ramifications if they default on repayments, Marcellus Investment Managers said in a blogpost on Oct. 23.

If not now, any inflating default risks in the retail unsecured loans in the future are likely to push credit losses by 50-200 basis points, according to a report by UBS Group AG. Credit costs is the amount of provisions banks have to take to make up for loan losses.

"New PL (personal loan) disbursement to borrowers with weaker credit profiles exposes this segment to a potential downcycle, in our view. NBFC and state-owned banks have a higher share of weak PL borrowers than large private banks," the brokerage said.

While Bajaj Finance remains cautious in the personal loan segment, HSBC Research said that the company's "own delinquency metrics are much better than comparable industry metrics".

NBFCs, in general, are more prone to stress in the unsecured personal loan segment. Nomura Global Research analysts estimate 250-300 bps credit costs in personal loans.

"Risks to earnings from deterioration in the unsecured portfolio appears low for banks, especially in light of the large contingency provision buffers that these banks carry," Nomura said in an August note.