RBI Warns of Rising Risks in Unsecured Loans and Financial Practices

The Reserve Bank of India (RBI) has expressed concerns about rising delinquency and high leverage in unsecured loans, urging for greater vigilance despite a slowdown in credit growth. In its Trends and Progress of Banking in India 2023-24 report, the central bank highlighted the importance of closely monitoring the connections between lenders and private credit firms.

The report shows that the gross non-performing assets (GNPA) ratio for banks has continued to fall, reaching a 13-year low of 2.7% in March 2024. By September 2024, this ratio had further decreased to 2.5%. Meanwhile, banks have seen a steady rise in profitability, marking their sixth consecutive year of growth. In the first half of 2024-25, the return on assets (RoA) was 1.4%, and the return on equity (RoE) stood at 14.6%.

One area of concern highlighted in the report is the growing share of unsecured loans in total credit extended by scheduled commercial banks. This share has steadily increased since March 2015, reaching 25.5% by March 2023. Although it slightly dropped to 25.3% by March 2024, the RBI has responded by introducing stricter regulations. In November 2024, the RBI mandated higher risk weights for unsecured loans and instructed both banks and non-banking financial companies (NBFCs) to set exposure limits. However, the report pointed out that some entities have set very high ceilings for these loans, which need to be closely monitored.

The RBI also raised concerns about the growing practice of top-up loans, which are often approved with minimal due diligence and lenient underwriting standards. The central bank found that there were instances where guidelines on loan-to-value (LTV) ratios, risk weights, and monitoring the end-use of funds were not followed properly. The RBI warned that these practices could lead to increased risks, especially if the collateral for such loans loses value or faces economic downturns. In response, the RBI had already directed banks to treat top-up loans as unsecured in the previous year and may consider further tightening regulations if needed.

Gold loans also came under scrutiny in the report, with the RBI pointing out several irregularities in loans against gold ornaments and jewellery. The central bank has urged lenders to improve monitoring of their gold loan portfolios and the oversight of outsourced activities and third-party service providers.

Another key issue raised was the private credit market. While the size of private credit firms remains small, the RBI noted that their inter-linkages with banks and NBFCs could pose systemic risks. These connections could potentially lead to regulatory loopholes, where firms might circumvent regulations

In terms of overall retail loans, the gross NPAs stood at 1.2% as of September 2024, the lowest among all sectors. However, agriculture loans had the highest GNPA ratio at 6.2%. Education loans saw a significant improvement, with the GNPA ratio dropping from 5.8% in March 2023 to 3.6% in March 2024, and further to 2.7% by September 2024. Despite this improvement, education loans still had the highest NPA levels among retail segments, followed by credit card receivables and consumer durables.

The RBI’s report underscores the need for continued vigilance and prudent financial practices to ensure the stability of the banking system and prevent potential risks in unsecured and retail lending.