At a time when banks are groaning under the weight of corporate loans going bad, there is another bubble building up on the retail portfolios of banks. The share of unsecured loans in the retail loans portfolio is rising sharply, with this type of borrowing growing faster than the overall credit growth in the country.
Nearly a third of outstanding retail loans in the banking system is unsecured, showed data released by the Reserve Bank of India (RBI) for July 2018. Outstanding retail loans to individuals as on July 20, 2018, stood at Rs 19.44 lakh crore, of which loans worth over Rs 6 lakh crore were unsecured — borrowings that are taken without providing any security or collateral.These unsecured loans include credit card outstanding, consumer durable loans and personal loans. The share of unsecured loans in the retail loan portfolio of banks increased to 31 percent in July 2018 from 26 percent in July 2016.
The credit card outstanding has shot up 73 percent while other unsecured personal loans (non-consumer durables) increased by 64 percent during the same period.
“There has been an increase in the credit appetite by Indians in the past few years. One of the major reason behind this is easy availability of credit,” Arun Ramamurthy, co-founder of Credit Sudhaar, a credit advisory firm which helps clients to improve their credit score.
Indeed, availing a loan has become very easy. The turnaround time and paperwork have reduced sharply. These days you can even get a loan sanctioned and transferred into your account, in less than an hour. New products such as consumer durable loans, payday loans, option to convert your purchases into easy EMIs too have been launched to entice potential borrowers. This has led to the blowing up of the unsecured portion of retail loans.
“Easy availability of credit is not that bad. Availability of credit is a boon when used well but can be a bane if used unwisely. But people have started leveraging more than their future cash-flows and are living way beyond their means. This is mainly because of lack of financial illiteracy among people,” said Ramamurthy.
A credit card is a classic example. Surprisingly, 30-40 percent of credit card users revolve on the credit card by only paying the minimum amount due of their credit card outstanding, which covers only the interest component, that too at a very high rate of interest around 35 - 40 percent and a very negligible portion of your principal amount.
Sample this. If someone borrows around Rs 1,00,000 on credit card and only pays the minimum amount due, it might take more than 10 years to repay the amount borrowed.
Overleveraging not only reduces your chances to get credit in the future and also dents your credit score. In cases of medical emergency, job loss or any such unforeseen circumstances, the potential to default on these loans is higher.
If you are wondering how borrowings continue unabated despite low credit scores, the answer is the slew of new products such as payday loans, instant personal loans etc. Borrowers get further credit with the help of these products but at a very high rate of interest.
But this ends up in a vicious cycle. Majority of the personal loan borrowers tend to apply for more credit in order to pay their EMIs of previously taken loans. For every new loan they take, their rate of interest also increases because they are already overleveraged and the credit score is low. It doesn't take much time to land in a debt trap.
“Around 30 crore people have a credit history (CIBIL score) in India, out of which, three crore people are already in a default situation. There is another set of around three crore people, which are on the verge of a default, having a very low credit score,” said Ramamurthy.
However, the bankers so far have been able to control the asset quality. The gross non-performing assets in unsecured personal loans were 3 percent as of March 2018, according to a recent research note released by CRISIL.
“The onus really lies on the borrower more than the bank. Banks are doing a good job and there is no need for incremental regulation, but credit literacy should be spread across and borrowers should be made aware of simple things – how credit works, consequences of defaults, and the benefits of not defaulting,” said Ramamurthy.
“We get more than a lakh registrations every month for our credit score improvement services. Most of the cases we get are not deliberate defaulters but ended up in a debt trap because of financial negligence or some unforeseen circumstances such as a job loss, family emergency etc.”“We have to educate people on financial literacy rather making lending stricter. The mutual fund sector has done a great job. AMFI’s - Mutual fund Sahi hai! Is a success story. The credit industry should soon find their way to educate people before this problem becomes too big to handle,” he added.