Is the Retail Credit Growth Sustainable?

In view of mounting NPAs banks shifting their exposure towards SME and retail segments to diversify the credit risk. In this article, Dr. Arindam Bandyopadhyay analyses the sustainability of this growth strategy.

Hyderabad: Commercial banks play an important role in the financial intermediation process. With the mounting non-performing assets (NPA) in the corporate loan segment and high indebtedness of companies, most of the scheduled commercial banks are now focusing on disbursing retail credit for the past three years.

Public sector banks (PSB) are also shifting their exposure towards the small and medium-sized enterprises (SME) and retail segments to diversify the credit risk.

Consumer credit such as unsecured personal loans, bank cards have been attractive to the banks due to higher yields. The government is also trying to push retail credit growth to bolster the economy.

Recently, the Reserve Bank of India (RBI) has reduced the risk weights for consumer loans from 125 percent to 100 percent to push the credit growth to stimulate economic growth. The reduction in risk weight would reduce the capital requirements and increase the banks’ desire for lending more. This may be considered as a countercyclical strategy to push growth.

Increase credit availability to push demand

In fiscal 2019-20, there has been a sharp deceleration in the gross domestic product (GDP) and private consumption growth. Greater availability of credit to the household sector is crucial to check the slowdown in the demand from the retail customers.

At the same time, banks and non-banking financial companies (NBFC) are required to increase the availability of credit to push the demand to fuel growth. But disbursing retail credit indiscriminately may give rise to higher credit risk in the retail segment. And the extra lending may invite higher risk and thereby erode bank capital if there is a herd behavior and all financial institutions try to target the same profile of retail customers.

The author’s study of data obtained from various published TransUnion CIBIL reports shows that on an average, 39.18 per cent of the sanctioned auto loans are going to 30 days past due (DPD) category in a year. In simple terms, DPD means for how many days the payment was delayed and in this case – the delay after 30-day threshold.

The study that covered the period between April-June 2016 and July-September 2019 reveal that the shift is 26.73 percent for the home loan.

This portion may be considered as early recognition of impairment of assets.

The study also shows that the estimated annual PD of auto loans is also high (16.68 percent). The two-year projected PD is going up to 27.01 percent.

Default Risk – Credit Growth Link

The predicted default risk in the home loan (or mortgage) and loan against property are also moderately high, which may slow down the credit growth in the future. Since banks are pricing their loans based on consumer risk, under the new external benchmarking regime, a rise in the delinquency rate (i.e. PD) will force the banks to increase the interest rate of retail loans to sustain their profitability.

Banks apply Marginal Cost of Funds based Lending Rate (MCLR) plus an additional spread based on expected credit risk. The higher interest rate will further decelerate the credit growth due to crowding-out effect. However, the credit growth in the personal loan and bank cards only appear to be sustainable in view of lower portfolio risk.

What is the solution?

Banks need to carefully segment their credit portfolios in terms of internal assessment of risk. The portfolio segmentation should be based on credit score obtained from CIBIL (prime versus sub-prime customers), loan to value ratio (LTV), EMI to income ratio, etc. to balance risk with return. A risk-adjusted view and risk-based pricing would enable the banks and financial institutions to incentivize the safer borrowers and limit the attendance of risky borrowers. This will also enable them to sustain retail credit growth on an ongoing basis.

(Written by Dr. Arindam Bandyopadhyay, Associate Professor, National Institute of Bank Management, Pune. Views are personal.)