Borrowers with multiple personal loans a big risk to profitability of banks and NBFCs

• Proprietary analysis done by UBS shows that borrowers with more than five personal loans rose from 1% in 2018 to 7.7% in March 2023.
• New disbursement of personal loans to borrowers with weaker credit profiles accounts for 22% of disbursements, which exposes this segment to a potential downcycle.
• State-owned banks and non banking financial companies have a much higher share of weak borrowers compared to private banks.
  

There’s a reason why lenders are luring consumers with multiple personal loans. In a bid to shore up loan books, lenders are indiscriminately lending to even those who cannot repay these loans. Raging inflation is not just burning a hole in the pockets of consumers. It is also impairing the ability of retail borrowers to repay their personal loans. In the aftermath of the pandemic, banks are in a better place when it comes to the headline figure on bad loans, but the defaults are rising sharply when it comes to personal loans that now account for more than 10% of outstanding loans for most banks.

This is not good news for stock pickers or investors as profitability of lenders – public and some private – will come under pressure because many of these retail borrowers will default. This would lead to higher credit costs and higher provisions. Bank stocks have been rallying this year as at an aggregate level, the gross non performing assets of banks have hit decadal lows. Bank Nifty is now trading at 1.9x its price to book value, which is lower than its 10-year average of 2.2x. Pressure on net interest margins and higher credit costs to impact earnings of banks and shadow banks over FY24 and FY25. Shares of State Bank of India are down 4.4% in the last one month, while that of other private banks is down between 2-4%.

While the Reserve Bank of India has been flagging off build up of stress in the retail loans segment, a deep dive into numbers is rather scary. According to analysis done by UBS, a global investment bank, shows that borrowers with more than five personal loans rose from 1% in 2018 to 7.7% in March 2023. Shockingly, new disbursement of personal loans to borrowers with weaker credit profiles accounts for 22% of disbursements, which exposes this segment to a potential downcycle.

This is perhaps the reason why RBI is worried over rising stress in the retail loan portfolio of banks. Stress is clearly building up in the retail loan portfolio of leaders, which can be unsecured or secured. Secured loans are typically backed by some form of collateral like gold or property, while unsecured loans are backed by nothing. In June, RBI’s financial stability report said that one in every ten such retail borrowers is missing on making payments for such unsecured loans. The reason it is worrying is that these retail loans have doubled in value between 2021 and 2023 compared to total advances.

In their bid to grow loan books, lenders are lending to consumers who are exhibiting their inability to repay such loans. Increasingly a lot of banks are now looking to issue unsecured loans to borrowers as they come with a higher interest rate. With corporates going easy on their borrowings, the retail credit boom has been the growth driver for most banks and non banks in India.

According to analysts, state owned banks and non banking financial companies have a much higher share of weak borrowers compared to private banks. However, the stress in retail loans has been building since 2021. HDFC in January 2022 sold stressed retail loans worth Rs 2188 crore to asset reconstruction companies.

Proprietary research done by UBS shows that unsecured loans as a percentage of total loans rose to 11.1% for State Bank of India, 12.8% for ICICI Bank and 10.7% for Axis Bank, but fell to 11.9% HDFC Bank (which merged with HDFC Limited) in June 2023. Says UBS in its report, “We believe the probability of regulators increasing the risk weight for personal loans is rising, and a 25% hike could lead to a 7- 40 bps drop in CET-1 ratios of banks we cover (SBI has a low buffer, in our view).”

The financial stability report by RBI says "Although the gross non-performing ratio of retail loans at the system level was low at 1.4% as of March 2023, the share of 'special mention accounts' was relatively high at 7.4% for scheduled commercial banks (SCBs) and it accounted for a tenth of their retail assets portfolio," RBI said in the report.