The increasing stress levels in unsecured retail loan books of banks can spiral out of control and create asset quality risks this fiscal to the tune of 25 percent over the past fiscal’s level, the international rating agency Fitch has warned.
Private sector banks like HDFC Bank, Kotak Mahindra Bank among other which have declared their Q3 earnings have reported massive spike in their retail, agriculture and MFI books.
“We forecast the banks’ impaired-loan ratio to fall by 40 bps to around 2.4% for the current financial year and by another 20 bps next fiscal, despite expecting new bad loans in FY25 and FY26 to be around 25 percent higher than in FY24” Fitch Ratings said in a report Thursday.
Rapid retail lending growth in recent years, particularly unsecured loans, has heightened medium-term risks, the agency said, adding “however, we still expect the impaired-loan ratio to fall in FY25 and FY26, driven by robust loan growth, as well as recoveries and write-offs, which are expected to offset the increase in fresh bad loans.”
The Reserve Bank expects the impaired-loan ratio to trough in FY25 before rising to around 3 percent in FY26, from the 2.6 percent in the first half of FY25.
“We believe the difference from our forecast partly reflects variance of opinions on the timing and extent of risk crystallisation, banks' exposure at risks, loan growth and the country’ overall economic performance,” the agency said.
Unsecured personal loans and credit card borrowings grew at 22% and 25 percent, respectively, in each of the past three years to FY24, but slowed to 11 percent and 18 percent, respectively in the first half of the current fiscal, after the RBI hiked the risk weights attached to unsecured lending by 25 percentage points in November 2023.
Although household debt remains low compared to many Apac emerging markets, at 42.9 percent of GDP as of June 2024, stress in unsecured retail loans has been rising, making up roughly 52 percent of new bad retail loans in the first half of this fiscal.
The impact of defaults on unsecured loans can be amplified as around 50% of borrowers reportedly hold at least one other, often high-value secured retail loan, such as a housing or vehicle loan, which could also be affected in the event of default, the report said.
Currently, lending stress appears to be concentrated in unsecured personal loans of under Rs 50,000.
“Large banks’ exposure to such riskier loans may be proportionally lower than the system’s, but they are not completely insulated, given their high loan growth appetite and increased digital lending in recent years. Banks may also have indirect exposure through funding to non-banks and fintechs, which are more exposed to low-income borrowers. Low-income borrowers, or those without income disclosure, constitute slightly over one-third of the system’s outstanding consumer credit,” the report said, adding this fast emerging risks could spill over to the higher income categories in a market downturn, given the correlation between rapid unsecured personal loan growth and increased retail participation in financial markets since FY20.
The report said exposure to unsecured personal and credit card loans banks it rates ranges between 2 percent and 15 percent of total loans. Accelerated write-offs, particularly private banks that are more aggressive lenders to this segment, likely played a role in keeping the bad-loan ratio in this segment muted at 1.7 percent in the first half of this fiscal, compared to the overall retail bad loan ratio of 1.2 percent, which includes lower-risk housing and vehicle loans, the report concludes.