The surge in consumer credit has been the major cause of the increase in unsecured loans. The Reserve Bank of India has expressed its concern over this matter and mentioned (in July 2023) that the retail loans had grown almost twice the pace of overall credit growth over the last two years. RBI has directed the banks and NBFCs (non-banking financial companies) to reserve more capital for risk weights.
Secured loans are those loans that have collateral to back them up if there are bad loans. Unsecured loans are those loans that do not have any collateral if the loans are not repaid. So, an increase in unsecured loans is a threat to an economy if the increase in secured loans is not as much. It means that the people are opting for unsecured loans which could lead to bankruptcy or debt traps.
An increase in personal loans or consumer credit of very small amounts for a short period indicates that the credit taken is often for ‘lifestyle’ spending rather than for a long-term or income-generating purpose. If a loan is taken to buy a house or a car or for investment purposes, there is always a collateral taken as well as a source of income that is generated. If not, there will be an asset. But these loans which range from 5,000 rupees to around 3 lakh rupees for less than a year are mostly to satisfy short-term spending. According to the CRIF Highmark (Centre for Research in International Finance) data, there has been an increase of 37 per cent in loans below Rs 10,000 and a 48 per cent increase in loans from Rs 10,000 to Rs 50,000 in the last financial year.
Why the Spurt
Some of the reasons for the increase in unsecured loans are as follows:
- Increasing availability The growth of consumer credit options like credit cards, credit applications, etc., has made credit available to consumers on a daily basis. It has made consumers opt for credit even if they do not need it. This encourages more spending on the part of consumers.
- Ease of access Easy access to credit through card and apps is also a major cause in the growing tendency of taking short-term loans. Consumers need not visit any bank or organisation, and the loan gets delivered to them with just a few phone calls.
- Consumerism One of the effects of globalisation is probably an increase in consumerism. Consider any product or service, India is one of the top consumers of it all. With this kind of stigma in society, the propensity to consume out of their incomes has increased, leading to dependence on the credit.
- Growth of NBFCs Banks generally lend and issue credit cards based on the consumer’s transactions, credit score, and profile. But the lending apps, which are NBFCs, issue these small loans that need only a credit score and an address proof, making it easy for the consumer to borrow without much problem. So, their propensity to spend by borrowing has increased.
- Pandemic The world, in general, has been affected by pandemic and many countries are still coping up from its effects. Many households just above the poverty line or from the lower-middle class sections, have slipped into poverty due to the lack of income as well as medical expenses during and after the COVID-19 pandemic. For many households, pandemic has been a start to the debt trap. With the availability and access, it has made them to borrow frequently, even for small short-term needs.
Implications of Bad Loans
With the easy availability of loans and the growing propensity to consume, especially over the last decade, people have increasingly inclined towards spending rather than saving. This behaviour shows an increase in consumerism. A growing amount of unsecured loans could lead to a debt trap for consumers if they cannot pay them back. Not only that but there is also a high chance that the lending apps charge huge amount of interest rates. For such small amounts, it is not possible to report easily but might lead to a bigger problem, if taken cumulatively.
If these unsecured loans go bad and do not receive their payment back, the companies may go bankrupt, and could impact the economy heavily. The availability of easy credit has made consumers buy things they, otherwise, could not afford.
Measures
The report mentioned that in the retail segment, the unsecured and secured advances were 9.8 per cent and 9.2 per cent, respectively, for public sector banks and 4 per cent and 5.4 per cent in private sector banks. Due to the growth of loans at a faster pace, RBI also mentioned that the banks are being closely watched for any kind of stress.
RBI has requested lenders to tighten personal loans after a surge in borrowing especially by low-income households. The central bank also suggested that the banks and NBFCs improve their surveillance, increase safeguards, and address risks, if any.
The risk weight for consumer credit exposure currently is 100 per cent for NBFCs and 125 per cent for scheduled commercial banks (SCBs). Now, RBI has increased the risk weight by 25 percentage points which is 150 per cent for SCBs and 125 per cent for NBFCs. This applies to personal loans except housing, education, vehicles, and loans secured by gold and jewellery, SHG loans, and micro-finance.
Conclusion
In an economy, consumption is as important as saving. Only saving and not translating the savings into investment and consumption leads to stagnation. Consumption will keep the economy running. The consumption theory of Keynes was one of the greatest solutions to the Great Depression. In a country like India, where savings are higher compared to other countries, it is important to spend. But an increase in spending in a higher proportion, and that too with credit and loans might hurt the economy, especially in the long run. Once consumer behaviour is accustomed to using small loans to fill the gap between income and expenditure, it becomes a regular habit to depend on credit to satisfy one’s needs on a daily basis. During the time of a crisis, this would worsen and throw them into a debt spiral. The majority of the population in this cycle is not a good sign for the economy.
Apart from that, with the increasing population, the cost of living and medical expenses, many households have slipped into poverty. The lack of a proper healthcare system and an insufficient growth in employment lead households to borrow in general. Before these cards and apps, there were mostly informal loans that were given at a very high interest rate. But with the apps and cards, these informal loans which the consumer used to take are now entering the formal sector and are being recorded.
On the brighter side, the percentage of these personal loans out of the entire loan is a very small amount. But the concern is not about the amount of loans, but the growth rate of these loans. If they do not pay back, it will make many lending companies and banks go bankrupt which will be a blow to the economy. So, if these loans can be controlled by creating more regulations and verifications before sanctioning them, it would reduce the number of at least those who are bound to default. Following the suggestions of the RBI and imposing a few regulations with self-interest, the lending organisations can save themselves and the economy from defaults as well as help individuals avoid these debt traps.
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