Tougher consumer lending rules will hit growth but mitigate risk: Fitch

New Indian regulations requiring lenders to hold more capital against unsecured consumer credit may curb growth but will strengthen financial stability, Fitch Ratings said in a report.

The tightening is a credit-positive effort by authorities to control emergent systemic risks posed by consumer credit, which has increased rapidly in recent years off a relatively low base, it said.

Growth in banks’ unsecured credit card loans and personal loans in the first half of the current fiscal stood at 29.9% and 25.5% year-on-year against total system-loan growth of 20%, Fitch said in its outlook.

“We believe increasing exposure to unsecured consumer credit – typically a riskier loan category – indicates greater risk appetite, as banks and NBFIs (non-banking financial institutions) seek to protect net interest margins amid stiff competition for secured retail loans,” it said.

To curb risks in consumer lending and apply brakes on the rapid growth of such loans, the Reserve Bank of India (RBI) last week raised the risk weights on consumption loans, credit card exposures, and loans to non-bank finance companies (NBFCs) by 25 percentage points each.

RBI said the consumer credit exposure for banks and NBFCs, excluding housing, education, vehicle, and gold-backed loans, will attract a risk weight of 125%, up from 100% earlier. The risk weight for credit card loans by banks has been raised to 150% from 125% earlier. Credit card loans by NBFCs will see a risk weight of 125%, up from 100%.

RBI governor Shaktikanta Das had cautioned against the rapid expansion in consumer credit and the growing dependence of NBFCs on bank loans in his meetings with leaders of major banks and large NBFCs in July and August.

Das reiterated the caution this week, flagging the contagion risk posed by NBFCs due to their extensive borrowing relationships with multiple banks, at the annual FIBAC event, organized jointly by the Federation of Indian Chambers of Commerce and Industry (Ficci) and Indian Banks’ Association.

The RBI governor spoke about on the risks to financial stability from exuberant retail lending; contagion risk from rising interconnectedness between banks and NBFCs; exorbitant rates charted by NBFC-MFIs and risks to credit quality from overreliance on algorithm-based retail lending.

“NBFCs are large net borrowers of funds from the financial system, with their exposure from banks being the highest. Banks are also one of the key subscribers to the debentures and commercial papers issued by NBFCs,” Das said.

In the July-September quarter, leading Indian banks, including HDFC Bank, ICICI Bank, and Kotak Mahindra Bank, saw unsecured loan portfolios expand by up to 30%.

India’s steps to curtail riskier bank lending to consumers will hit loan growth and squeeze the NBFC’s in particular, S&P Global report said in a report earlier this week.

Analysts had earlier cautioned that rising unsecured credit risk could affect lenders’ capital adequacy ratios (CARs), which are crucial indicators of a bank’s ability to absorb losses and maintain solvency in tough financial situations.

Private banks, which have relatively better capitalization than state-run banks, should continue to have reasonable capitalization after the change and are better positioned to source fresh capital if needed, given their higher price-to-book valuations, Fitch said.

“We believe the measures by themselves are unlikely to lower banks’ capital scores or standalone viability ratings (VRs), although SBI’s VR headroom may narrow. The measures should reduce the risk of adverse impacts linked to sustained declines in core capital buffers amid high loan growth and risk addition over the medium term,” it added.

Finance minister Nirmala Sitharaman also backed RBI’s move to curb exuberance in lending, saying NBFCs and small finance banks needed to remain cautious.

“RBI is quite conscious of where the thin line actually lies. Enthusiasm is good but sometimes it becomes a bit too far for people to digest. So, as a measure of caution, RBI has also alerted small finance banks and NBFCs to be careful that they don’t go too far too soon and face any downside risks later,” Sitharaman said the Digital Acceleration and Transformation Expo event in New Delhi on Thursday.