India Ratings (Ind-Ra) has raised concerns about the surge in unsecured lending in India and has called for higher capital buffers and closer monitoring of unsecured advances by non-bank lenders. As the country’s non-banking financial companies (NBFCs) witnessed a sharp rise in assets under management (AUM) to Rs 10.3 lakh crore in FY23, a 19% increase compared to 9.6% in FY22 and 3.3% in FY21, the rating firm expressed caution over the potential risks associated with the growing unsecured loan portfolio.
The surge in unsecured retail loans has been facilitated by FinTech companies partnering with large NBFCs to sell such loans. These partnerships offer better yields and improve the granularity of the loan book for NBFCs.
Demand revival
Ind-Ra highlighted the revival in pent-up demand and a rebound in service activities and consumer spending as significant factors contributing to the robust growth in NBFCs’ loan portfolios. However, it also warned that a secular rise in the proportion of unsecured loans necessitates holding higher capital buffers to absorb potential credit losses. The rating firm emphasised the importance of monitoring the leverage levels and book composition to ensure that NBFCs can weather asset quality shocks effectively.
TransUnion Cibil, a credit bureau, had previously noted that digital and information-oriented lending were driving the growth of retail credit, especially in the unsecured loans segment. While retail credit remained on a strong and steady growth trajectory, segments such as unsecured loans required closer monitoring to ensure sustained and long-term growth.
The risks
However, Ind-Ra cautioned that the credit cost behaviour for unsecured loans could differ significantly from that of secured loans, which are traditionally carried on NBFCs’ balance sheets.
Furthermore, credit loss protection guidelines from regulators provide some clarity on the quantum of credit loss that can be absorbed in partnership arrangements between FinTechs and NBFCs. As the regulatory landscape evolves, these partnerships are expected to gain traction, making FinTechs and large NBFCs significant players in the unsecured lending space.
Ind-Ra also expressed concerns about the increased assets under management in the FinTech space. While this growth is expected to continue, the rating firm cautioned that the guidelines on default loss guarantees must be strictly adhered to. FinTechs focusing on unsecured loans may face challenges in absorbing credit losses due to their evolving underwriting models and higher operating expenses.
The report also pointed out that FinTechs’ business models hinge on maintaining a steady disbursement rate, as their earnings rely on fee income and spread income based on the volume of disbursements. Any slowdown in disbursements could impact profitability for fintechs operating at their current scale.
