Don’t increase unsecured loans exposure: RBI to banks

Don’t increase unsecured loans exposure: RBI to banks

Subject :Economy

Section: Monetary Policy

Why in News?

As part of increasing caution amidst growing macro-economic uncertainties and bank collapses in the US and Europe, India’s central bank is asking banks to be watchful over their retail portfolios, particularly the unsecured loans. These include personal loans, credit cards, small business loans and micro finance loans.

The overall share of unsecured loans as an average across private banks has increased by over 300 basis points since June.

Latest Credit Deployment Data

• It is published by RBI.
• Unsecured loans lent between February 2022 to February 2023 stood at ₹2.2-lakh crore, higher than the deployment towards large corporates at ₹1.18-lakh crore.
• The size of the home loan market during this period was ₹2.49-lakh crore just marginally larger than the unsecured loans market.

What are Unsecured Loans?

• In unsecured loans, the borrowers’ assets are not pledged as collateral.
• Examples of such loans are personal loans, education loans, credit cards etc.
• They are given out on the basis of credit worthiness of the borrowers.
• The interest rates on unsecured loans is higher than the secured loans. This is mainly because the options for recourse for lender in case of unsecured loans are limited.

Previous Measures

• In 2019, the risk weight on unsecured loans excluding credit cards was reduced from 125 per cent to 100 per cent to place them at par with other retail loans. It was also done to harmonise the risk weights to Basel-III requirements.
• Despite repeated warning to banks, especially private banks, unsecured loans growing faster than the secured retail loans may lead to increase in risk weights by RBI.

Basel III Requirements

Basel III is an internationally agreed set of measures developed by the BCBS in response to the financial crisis of 2007-09. The measures aim to strengthen the regulation, supervision and risk management of banks.

Basel 3 measures are based on three pillars:

Pillar 1: Improve the banking sector’s ability to absorb ups and downs arising from financial and economic instability

Pillar 2: Improve risk management ability and governance of banking sector

Pillar 3: Strengthen banks’ transparency and disclosures

Basel Committee on Bank Supervision (BCBS)

1. It is a committee under the Bank for International Settlements.
2. Established in 1930, the BISis owned by 60 central banks, representing countries from around the world that together account for about 95% of world GDP.
3. Its head office is in Basel, Switzerland.
4. Its mission is to serve central banks in their pursuit of monetary and financial stability,to foster international cooperation in those areas and to act as a bank for central banks.

No Proper Checks

• Adequate credit checks may not be in place due to securitization of personal loans and 30-minutes sanctioning.
• Difficult to assess the exact asset quality of such loans
• So, to avert a systemic risk, the pace of growth in the unsecured loans should be reduced. Even on the Microfinance side banks should not overdo growth despite the improvement in demand and collection efficiencies of MFI loans.

Sachetisation of Loans

1. This means loans can be broken down into levels that actually suit the needs of the borrowers, while keep lenders interested
2. If the loan’s tenure and terms are designed flexibly to align with borrowers’ cash flow cycle, the whole exercise is bound to be sustainable

MFIs

Microfinance institutions (MFIs) are financial companies that provide small loans to people who do not have any access to banking facilities.

Small Finance Banks

• Small Finance Banks are the financial institutions which provide financial services to the unserved and unbanked region of the country. They are registered as a public limited company under the Companies Act, 2013.

NBFCs

• NBFCs are financial institutions that provide various financial services and products, including loans, insurance, and asset management, but do not have a banking license. Unlike banks, NBFCs do not have the authority to accept deposits from the public.