The Reserve Bank of India (RBI) has raised concerns about the growing risks associated with unsecured lending and private credit markets, urging heightened vigilance amidst a cooling credit growth environment. In its annual report on Trends and Progress of Banking in India 2023-24, RBI underscored the need to carefully monitor the growing interlinkages between lenders and private credit firms, which could pose systemic risks.
Despite these concerns, India's banking sector has seen a steady decline in gross non-performing assets (GNPA), which reached a 13-year low of 2.7% in March 2024, further dipping to 2.5% by September. Banks' profitability also continues to grow, with return on assets (RoA) at 1.4% and return on equity (RoE) at 14.6% in the first half of 2024-25.
According to the report, the share of unsecured loans in the total credit portfolio of scheduled commercial banks has increased consistently since 2015, reaching 25.5% in March 2023, although it slightly eased to 25.3% by March 2024. In response, the RBI introduced stricter regulations in November 2024, including higher risk weights for unsecured loans and guidelines for banks and non-banking financial companies (NBFCs) to establish exposure limits.
"However, some entities have fixed very high ceilings, which need to be continuously monitored," the report noted. RBI emphasised the importance of prudence in managing these risks to ensure the financial stability of regulated entities.
Further, top-up loans have also drawn the regulator's attention. While top-up loans provide additional credit facilities to customers based on the strength of their existing collateral, such as houses, automobiles, or gold, many regulated entities (REs) may perceive such secured loans as having lower risk. RBI says such additional facilities are often sanctioned with minimal processes and due diligence, with liberal underwriting standards and lax adherence to prudential guidelines on loan-to-value (LTV) ratios, risk weights, and without ensuring the end-use of funds. "These practices could lead to a build-up of risks, especially during times when collaterals for such loans become volatile or face cyclical downturns."
Given these concerns, in November 2023, RBI instructed that all top-up loans extended by REs against movable assets, which are inherently depreciating, should be treated as unsecured loans for credit appraisal, prudential limits and exposure purposes. "The Reserve Bank will assess the need, if any, for additional regulatory interventions to mitigate the identified risks in cases of other top-up loans."
In response, RBI has directed banks to treat top-up loans as unsecured and hinted at tightening regulations further if necessary.
Gold loans were another concern, with RBI pointing out irregularities in loans secured against gold ornaments and jewellery. Banks have been urged to improve oversight of their gold loan portfolios and third-party service providers to prevent further risk accumulation.
RBI also called for a closer examination of the private credit market, noting that while these firms are currently small, their connections with banks and NBFCs could lead to systemic issues and regulatory evasion.
In the broader retail lending segment, gross NPAs stood at 1.2% as of September 2024, the lowest among sectors, with agriculture showing the highest GNPA ratio at 6.2%. Education loans have seen notable improvement, with GNPA ratios falling from 5.8% in March 2023 to 2.7% by September 2024. However, education loans continue to face the highest NPA levels among retail segments, followed by credit card debts and consumer durables.