NBFC

RBI’s Intensified Review of NBFC Loan Expansion: Key Concern

The RBI, over the past few months, has begun to tighten the screws on NBFCs signalling heightened regulatory scrutiny of their rapid loan growth. With soaring credit demand across consumer and business segments, the central bank has started to worry about the sustainability of such growth and resultant systemic risks.

Recent developments have brought the issue to the centre, with the RBI seeking comprehensive data from selected NBFCs over their loan portfolios, raising apprehensions of an impending credit bubble. In this blog, we will discover the reasons behind the RBI’s move, the areas under examination, and the wider ramifications for India’s financial ecosystem.

Role of NBFCs in India’s Financial Landscape

Before proceeding with the recent measures taken by the RBI, let us know how NBFCs function within the Indian financial ecosystem. To start with, NBFCs are different from traditional banks as they work on being very critical sources of credit for underbanked and under-served sections of the population, comprising individual people, small enterprises, and rural businesses. They cater to different segments of borrowers, from products about personal loans and home loans to vehicle financing and microloans.

NBFCs, powered by the adoption of technology, relaxed lending norms, and a growing middle class needing immediate access to credit, have seen rapid growth over the past decade. Ultimately, this is also reflected in the unsecured loan segment, which houses personal loans, payday loans, and short-term credit products. NBFCs, including fintech lenders, could meet the evolving demand supported by digital platforms, alternative credit scoring models, and reduced time of disbursement.

However, with such rapid expansion, there have been concerns about whether NBFCs maintain adequate safeguards against systemic risks. One major reason for the RBI’s intervention is to ensure that this growth becomes sustainable and in tune with the tenets of sound financial hygiene.

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Drive Behind the RBI’s Request for Detailed Data from NBFCs

The RBI has sought detailed data from select NBFCs regarding their loan portfolios, particularly concerning product types and interest rates charged to borrowers. The RBI will be most keen to understand the composition of NBFC loan portfolios, whether the loans are skewed towards higher-risk categories such as unsecured credit, and whether rates charged are also in accordance with lending ethics. This data request essentially has the following interest rate slabs:

• Less than 10%
• 10-20 %
• 20-30%
• 30-40%
• 40-50%
• More than 50%

The interest rate focus reflects the RBI’s apprehension about some NBFCs’ predatory lending, especially in the unsecured personal loan market. Rates of over 30% raise red flags about borrowers falling into debt traps, where they cannot pay their dues and, as a result, default. As aptly reviewed by RBI, three concerns were raised by them which they want to address:

• Systemic Hygiene: First, it needs to be gauged whether the rapid loan growth is sustainable and, further, whether NBFCs have prudent lending standards.
• Risk of Credit Bubble: In this case, the regulator is eager to know if there is any early warning signal of undue risk-taking in certain categories.
• Fair Practices Code: The RBI tries to ensure that lenders do not take advantage of the weaker sections of society by charging inflated interest rates.

Growing Concerns Over NBFC-Fintech Lenders

One of the largest developments in the recent past has been the rise of fintech NBFCs, which have leveraged technology to transform the lending space. Such companies use alternative credit scoring mechanisms based on digital footprints like social media activity, digital payment history, and other non-conventional factors to make credit decisions for borrowers.

Fintech-driven lending has been a boon for financial inclusion but has also given rise to risks. In its Financial Stability Report (June 2024), the RBI said that fintech lenders hold the largest share of credit in the consumer credit segment, especially loans below ₹50,000 in value. However, these loans also carry some of the highest delinquency rates in the financial system.

Delinquency, or inability of borrowers to meet their repayment obligations, is a growing concern. It was reported that regarding personal loans, the vintage delinquency rates stood at 8.2%. This raises several questions about the robust underwriting standards of FinTech NBFCs.

While banks depend heavily on credit scores from established agencies, fintech NBFCs are more eager to take on riskier borrowers and are betting heavily on alternative data to drive lending decisions. The RBI’s scrutiny extends beyond the mere interest rate and loan portfolio. It is also about the quality of credit these new-age lenders give and how sustainable their business models will be when delinquencies mount.

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Systemic Risks and the Credit Bubble Threat

The central theme of many driving factors behind the RBI’s data request is the possible risk of all credit bubble formation, especially in the unsecured loan segment. A credit bubble involves lenders extending loans to borrowers who cannot afford the repayments, ultimately leading to mass defaults and an eventual collapse in the value of the underlying loan assets.

The Indian economy is no different, having seen unprecedented growth in the consumer credit market. Growing middle-class households and increasing disposable incomes have seen consumers increasingly look towards NBFCs and digital lenders for short-term loans. While this has played an instrumental role in fuelling consumption and growth, it comes with its risks.

Unsecured personal loans, not backed by collateral, are more prone to defaults as the borrower’s repayment capability is often undetermined. Delinquency rates are already high in the loan bracket below ₹50,000, so the risks of defaults cascading across the financial system are not merely notional.

The RBI does not want a repeat of the past crises, which sent shockwaves across the NBFC sector with far-reaching implications for the broader financial system. Central to the problem now is the preparedness of NBFCs in an economic slowdown that may lead to a rise in defaults and expose fissures in their loan portfolios.

Recent Regulatory Measures by the RBI

To address these issues, RBI has already taken several regulatory measures to rein in excessive risk-taking by NBFCs. Last month, the central bank asked regulated entities to review their consumer credit exposure limits and set board-approved thresholds for different loan sub-segments. This was directed more at unsecured consumer credit, which has seen some of the fastest growth over the last few years.

These proposals ensure that NBFCs maintain a balanced portfolio and do not overexpose themselves to high-risk loans. The RBI has given NBFCs until 29 February 2024 to implement these exposure limits. This move underlines the central bank’s will to ensure that NBFCs do not overextend themselves in search of rapid growth.

The regulator focuses on unsecured credit because these loans are most susceptible to defaults in such a macroeconomic setting where interest rates and inflationary pressures are high. It is with this view that the RBI tries to restrict the extent to which NBFCs can lend to such high-risk segments and, thereby, reduce the probability of a systemic crisis due to widespread loan defaults.

Glimpse of Future Outlook for NBFCs

The RBI’s increased scrutiny comes when NBFCs are pressured to maintain their growth pace amidst heightened competition and regulatory tightening. In the days ahead, NBFCs must balance growth and prudence. On the one hand, NBFCs play a very important role in propagating financial inclusions among rural and backward people. Their reach to borrowers who could not access traditional bank loans is an essential driver of economic growth.

Conversely, unchecked loan growth, especially in high-risk categories, may result in systemic fragilities threatening the financial system’s stability.

NBFCs would overcome the difficult environment by reinforcing their risk management framework. This would include tightening credit underwriting standards, adopting more advanced data analytics to evaluate borrower risks, and extending loans only to borrowers who are capable of repaying them. Secondly, NBFCs must reduce exposure to unsecured personal loans and gradually diversify their portfolios to secured lending products with lower default risks.

To Wrap Up

A spate of recent moves by the RBI passes a clear message that the days of rampant loan growth for NBFCs are finally ending. NBFCs have been instrumental in driving financial inclusion and credit growth in India. Still, the fast pace of development, especially in the unsecured loan segment, poses some nagging questions over the viability and sustainability of their business models.

The RBI’s move to seek detailed information speaks of an institutional proactive approach to early identification of qualitative risk while ensuring that lenders operate on fair lending principles and systemic hygiene. For NBFCs, the challenge will be to adapt to this new era of heightened regulatory oversight while continuing to serve the ever-evolving credit needs of a growing, increasingly diversified population.

With the implementation deadline for the exposure limits drawn near in February 2024, NBFCs focused more on striking a fine balance between growth and stability. From the borrower’s perspective, this RBI intervention assures that the central bank does not want them to fall prey to predatory lending practices and that the financial system must be resilient to emerging risks.

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