Fitch Ratings has warned that rising stress in Indian banks' unsecured retail loan portfolios could present risks to asset quality projections for the sector in 2025. The rating agency forecasts that the banking sector's impaired-loan ratio will decline by 40bps (basis points) to about 2.4% for the financial year ending March 2025 (FY24-25), followed by a further 20bps improvement in FY25-26. However, this projection comes amidst an anticipated 25% increase in new bad loans in FY24-25 and FY25-26 compared to FY23-24, Fitch says.
Fitch says, "The current lending stress appears concentrated in unsecured personal loans of less than US$600. While large Indian banks may have proportionally lower exposure to these riskier loans, they remain vulnerable due to their aggressive loan growth strategies and increasing digital lending. Additionally, banks may face indirect risks by funding non-banking financial companies (NBFCs) and fintechs, which cater more to low-income borrowers."
"Low-income borrowers, or those without disclosed income, account for just over one-third of the system's outstanding consumer credit. In a market downturn, risks could extend to higher-income categories, as there has been a strong correlation between the surge in unsecured personal loans and increased retail participation in financial markets since FY20. However, Fitch expects borrowers in these higher-income segments to be more resilient," the rating agency says.
The rapid expansion of retail lending in recent years, particularly in unsecured loans, has heightened medium-term risks, the rating agency says, adding, "Despite these concerns, the impaired-loan ratio is still expected to decrease, supported by strong loan growth, recoveries, and write-offs, which should help counterbalance the increase in fresh bad loans."
The Reserve Bank of India (RBI) predicts that the impaired-loan ratio will bottom out in FY24-25 before climbing to around 3% in FY25-26, up from the 2.6% recorded in the first half of FY24-25 (H1FY24-25). The variance between Fitch's forecasts and RBI's projections reflects differing opinions on risk crystallisation timing, banks' exposure, loan growth and broader economic conditions in India, the rating agency says.
According to Fitch, in the three years leading up to FY23-24, unsecured personal loans and credit card borrowings have experienced significant growth, with a compound annual growth rate (CAGR) of 22% and 25%, respectively. However, following an increase in risk weights for unsecured lending, this growth slowed to 11% and 18% year-on-year (y-o-y) in H1FY24-25, it added.
Although India's household debt remains relatively low at 42.9% of GDP as of June 2024 compared to other emerging Asia-Pacific (APAC) markets, stress in unsecured retail loans is rising, Fitch says. "These loans accounted for around 52% of new bad retail loans in the first half of FY24-25. The impact of defaults on unsecured loans is compounded by the fact that approximately 50% of borrowers also hold at least one high-value secured loan, such as a housing or vehicle loan, which could be affected in the event of default."
Fitch-rated banks' exposure to unsecured personal and credit card loans ranges from 2% to 15% of total loans. It says accelerated write-offs, particularly by private banks with higher lending appetite in this segment, have helped keep the sector's unsecured retail bad-loan ratio at 1.7% in H1FY24-25 and remains higher than the overall retail bad-loan ratio of 1.2% which includes lower-risk housing and vehicle loans.
Despite concerns, Fitch notes that impaired loan ratios for Fitch-rated banks have improved in recent years, providing some buffer for asset quality deterioration before affecting their credit ratings. The issuer default ratings (IDRs) of Fitch-rated Indian banks remain driven by expectations of high to moderate state support in times of distress. However, their stand-alone viability ratings (VRs) remain below their government support ratings, reflecting constraints linked to their risk profiles, the rating agency says.
The six State-owned banks rated by Fitch have VRs that are restricted by their risk appetite, underscoring the importance of risk management and control in future assessments.
With growing concerns over unsecured lending stress, the rating agency concludes that Indian banks will need to exercise prudence in their lending strategies, while ensuring robust risk management to maintain asset quality and financial stability in the coming years.
