13/01/2025
RBI Urges Stricter Prudential Norms to Mitigate Unsecured Loan Vulnerabilities
The Reserve Bank of India (RBI) has expressed concerns regarding the rising trend of high ceilings set by banks and non-banking financial companies (NBFCs) for unsecured loans. While there has been some moderation in unsecured lending after the central bank tightened norms for this segment, RBI remains cautious. It highlighted that urban cooperative banks (UCBs) have specific limits on unsecured lending, but commercial banks and NBFCs enjoy discretion in setting their exposure limits. However, some entities have set ceilings that are alarmingly high, which requires continuous monitoring. RBI expects the boards of these regulated entities to exercise prudence and avoid over-enthusiasm to safeguard their own financial health and ensure systemic financial stability.
RBI has also raised concerns about certain practices that amplify risks in lending. For instance, top-up loans on gold loans, often treated as collateral-backed, may present risks similar to unsecured loans, particularly during periods of volatility or cyclical downturns in the value of collateral. The central bank noted that inadequate due diligence and lenient underwriting standards in such cases could lead to vulnerabilities in the financial system. This comes as retail-loan defaults have surged in India due to aggressive lending practices, creating ripple effects in the stock market and raising fears of a broader economic impact. Several lenders, including prominent names like Kotak Mahindra Bank Ltd. and IndusInd Bank Ltd., have reported elevated stress in their unsecured loan portfolios, leading to stock price declines. Smaller lenders, such as Ujjivan Small Finance Bank Ltd., which primarily focus on smaller-ticket loans, have been hit particularly hard, with their stock falling over 30% this year.
The slowdown in personal-loan growth has become evident following the RBI’s clampdown on risky lending practices introduced in November 2024. The new guidelines mandated higher risk weights for unsecured loans and required banks and NBFCs to set stricter exposure limits. As a result, the impact of these regulations is now trickling into company earnings and signaling potential challenges ahead for India’s economy, which is still the world’s fastest-growing major economy.
Additionally, the rising financial strain on borrowers in the unsecured retail loan segment, which includes microfinance and personal loans, is leading to a significant uptick in the acquisition of bad debts by Asset Reconstruction Companies (ARCs). According to the Association of Asset Reconstruction Companies, the book value of total assets acquired by ARCs rose 15% in FY24, reaching ₹9.7 lakh crore, a ₹1.2 lakh crore increase from the previous year. This indicates growing stress in the unsecured loan segment, as the share of unsecured loans in total credit extended by scheduled commercial banks steadily grew from 2015 to 25.5% by March 2023, before easing slightly to 25.3% a year later.
The rise of fintech companies and digital lending platforms has further contributed to the rapid growth of unsecured loans. Digital lending has become more accessible, fueled by increased smartphone penetration, affordable internet access, and growing credit demand. Innovations in lending models such as Buy Now, Pay Later (BNPL), Peer-to-Peer (P2P) lending, and co-lending have revolutionized the banking and financial services sector. This growth is projected to propel India’s digital lending industry to $515 billion by 2030. However, the ease of accessing loans through digital channels, coupled with flexible credit products, has also contributed to mounting risks, particularly due to inadequate due diligence and the absence of robust regulatory oversight in certain cases.
To address these challenges, the RBI has called for stricter adherence to prudential guidelines, including monitoring end-use of funds, ensuring appropriate loan-to-value (LTV) ratios, and applying higher risk weights for unsecured loans. While the digital lending ecosystem continues to grow, the regulator’s concerns underscore the need for a balanced approach that fosters innovation while safeguarding financial stability. Going forward, prudent practices by banks, NBFCs, and fintech players, combined with continued regulatory vigilance, will be crucial to mitigating risks in the unsecured lending space and supporting sustainable growth in India’s credit market.