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The “Goldilocks” moment for lenders riding the wave of demand for loans from retail customers while maintaining clean balance sheets may have clouded. These firms are grappling with an increase in bad loans, margin compression and intense competition for deposits, according to bankers and analysts.
Shaktikanta Das, Reserve Bank of India’s governor, said last month that even though the overall sector remains healthy, there are outliers who pursue an “imprudent, growth-at-any-cost approach,” which is counter productive. A week later, the central bank stopped new loans at four shadow banks.
Shadow lenders typically target customers underserved or unserved by banks because of a limited credit history and low income. They accounted for 15% of assets in the financial system as of March 2023, according to the RBI. While these lenders boost profits through higher interest rates on loans, they’re more vulnerable to defaults when the economic cycle turns, according to Moody’s Ratings.
BloombergEven though they are a small part of overall lending, the signs of stress are prompting firms to pull back on personal loans, a move that may impact growth. Shadow lenders’ asset growth will slow to between 16% to 18% in fiscal 2025, down from 25% in the prior fiscal year, according to rating agency Icra Ltd.
Bajaj Finance, one of the largest unsecured lenders, is cutting the number of clients with multiple loans, according to a presentation.
Axis Bank Ltd. is also slowing disbursements on unsecured products. “There is no acceleration in that business that’s happening at this point,” said Subrat Mohanty, executive director, banking operations & transformation at Axis Bank, referring to personal loans. The surge in bad loans on credit card, personal loan and microfinance portfolios comes nearly a year after the banking regulator tightened rules for unsecured loans, trying to get ahead of any blow-ups.
More than six years ago, a pile-up of bad loans years in the making dragged on growth, pushing the government to overhaul bankruptcy laws and recapitalize state-owned banks.
RBI last year asked shadow lenders and banks to increase buffers for some consumer loans in an effort to check the “exuberance” in unsecured loan growth. It also mandated banks to increase their risk weightings to the non-bank sector.
Household savings had dropped to a multi-year low and Indians were borrowing record amounts on their credit cards and loading up on other debt, raising concerns of a build up of systemic risk.
“Without Reserve Bank of India’s action last November, the current situation could have been worse,” said Amod Khanorkar, chief rating officer at Infomerics Ratings.
“Individual borrowers have taken personal loans to consume things they cannot afford due to limited incomes,” said Nirmal Jain, founder of IIFL Group, a financial services conglomerate, whose loan losses and provisions rose by 62% in the September quarter from the previous three-month period. “This has triggered defaults in those loans.”
In addition to personal loans, risk is also building in loans to small and medium-sized businesses, where the lines between personal and corporate credit is blurry, according to a consultant who advises several financial institutions, and asked not to be identified citing confidential discussions.
BloombergShadow lenders, including Bajaj Finance and Piramal Enterprises Ltd., pointed to over-leveraged borrowers for the rise in non-performing assets, and said they were tightening underwriting norms. Bajaj Finance’s soured loans expanded to 1.06% in the September quarter, up from 0.91% the prior year.
These lenders aren’t the only ones saddled with higher bad loans. Kotak Mahindra Bank Ltd.’s gross non-performing assets expanded to 1.49% from 1.39% in the previous quarter, largely driven by stress in credit cards.
Likewise, Axis Bank saw a worsening of asset quality in some of its unsecured loans and other asset classes, according to Amitabh Chaudhry, its chief executive officer.
The situation was more dire for smaller private lenders like IndusInd Bank Ltd. that reported a quarter-on-quarter decline of 38% in profit as its credit costs increased because of higher slippages in the microfinance segment.
Cut Exposure
“The only way out here is to reduce the exposure,” wrote Suresh Ganapathy, head of financial services research at Macquarie Capital, in a note.
Already, credit growth has moderated sharply to 12.8% year-on-year as of Oct. 25, from 19.3% a year earlier, according to RBI. All consumption-led products like credit cards, consumer durable loans and personal loans are experiencing a tightening of capital, according to TransUnion CIBIL.
Firms have to improve their underwriting standards to stem the rise of bad loans on their books, Khanorkar said, adding that shadow lenders and fintechs will bear the brunt of increased defaults and credit costs.
“Going forward, non-banks will go slow in unsecured personal loans amid cautionary signals,” said IIFL’s Jain.