High delinquency in sub-50k personal loans: A systemic risk warning or mere teething troubles?
An alternate viewpoint on the high delinquency in emerging loan segments
Consumer credit is back in the spotlight with the latest RBI’s Financial Stability Report painting a rather grim picture of the state of delinquency in the segment. Well, before we paint the entire segment with the same brush, let’s break it down.
Consumer credit has been a major driver of banking business over the last decade and continued to remain robust during the second half of this financial year.
If you look at ‘inquiry volumes’ data, the steady credit demand across loan products becomes clear — except for some level of moderation in the personal loans and credit card segment.
Inquiry volumes by product category
On the growth front, the impact of risk weights is evident. Even as inquiry volumes remain robust, the impact of increase in risk weights on certain segments of consumer credit pulled down the overall rate of growth, especially personal loans and credit cards.
Delinquency levels remained low across financial institutions and product categories with the share of low-rated borrowers in incremental credit continuing to decline. Despite overall improvement in asset quality — yet again, personal loans continue to lag.
Consumer Credit - Asset Quality
Personal loans — the Achilles heel of consumer credit?
What the RBI found most concerning is the high level of delinquency among borrowers with personal loans below ₹50,000. In particular, NBFC-Fintech lenders, which have the highest share in sanctioned and outstanding amounts, also have the second highest delinquency levels, only below that of small finance banks (see figure below).
Delinquency Levels - Personal Loans (Below Rs. 50,000)
While the RBI's concerns about the consumer credit segment, especially the sub-50k personal loan segment, are valid, there are several arguments that suggest the situation may not be as alarming as it appears.
Firstly, personal loans below Rs 50,000 constitute only 0.4% of the total outstanding retail loans of financial institutions. This means that even if delinquency levels are high in this segment, their overall impact on the financial system is relatively minor.
Secondly, it’s a clear sign of economic inclusion. High delinquency levels in the sub-Rs 50,000 segment reflect greater access to credit for financially underserved populations. These borrowers might not have had access to credit in the past, and while some delinquencies are expected, the overall increase in financial inclusion could have long-term positive effects on the economy.
Thirdly, the fact that maximum exposure in this segment lies with NBFC-FinTech players, typically more agile and innovative, may be good news. They may be better positioned to manage risks through technology-driven credit assessment and recovery processes. This adaptability could mitigate the potential negative impact of high delinquency rates.
Another major point highlighted by the FSR was regarding vintage delinquency — a commonly used industry metric to assess the efficiency of the loan underwriting process. It is defined as the percentage of accounts that have become delinquent (90+ days past due) within twelve months of origination. The bad news is that it remains relatively high in personal loans at 8.2 per cent, as per the FSR report.
Well, high vintage delinquency rates do point to initial challenges in loan underwriting. However, as NBFCs and fintech lenders gain more experience and data, their credit assessment processes are likely to improve, leading to lower delinquency rates in the future.
The report also said that little more than a half of the borrowers in this segment have three live loans at the time of origination and more than one-third of the borrowers have availed more than three loans in the last six months. While this may raise concerns about over-leverage, it also highlights robust credit demand, borrowers' access to multiple credit sources, and their ability to manage several financial obligations concurrently.
Just to play the devil's advocate, one could also argue it as debt consolidation strategy. Many borrowers might be taking multiple loans for the purpose of consolidating existing debt at more favourable terms. This can be a prudent financial strategy to reduce interest costs and manage repayments more effectively.
The bottom line
While the concerns highlighted by the RBI should not be dismissed, a comprehensive view of the context and potential mitigating factors suggests that the situation may be manageable and that steps are being taken to address the underlying issues – case in point RBI’s measure to increase risk weights.
In any emerging segment, it's crucial to allow time for equilibrium. Market forces need the space to align interest rates with the precise risk of default based on borrower characteristics. With approximately 40% of consumer credit catering to new-to-credit, sub-prime, and near-prime segments, patience and strategic intervention are essential.