In a bid to fortify the stability of the financial system, policy researchers are advocating for the inclusion of a new parameter, the Debt-to-Income (DTI) ratio, when evaluating the creditworthiness of individuals seeking retail loans. This move is aimed at preventing potential adverse impacts on the overall system, according to a research paper released by economists at the Reserve Bank of India (RBI).
“Policy makers are encouraging lenders to use emerging technology ecosystem, viz., account aggregators, to seek requisite consent from the borrowers; strengthen credit underwriting; and strengthen monitoring of models. Besides enabling greater flexibility both in terms of product and pricing choices for the borrowers, such frameworks facilitate monitoring of borrower leverage in a holistic fashion,” the paper d “Dynamics of Credit Growth in the Retail Segment: Risk and Stability Concerns” authored by Vijay Singh Shekhawat, Avdhesh Kumar Shukla, ACV Subrahmanyam, and Jugnu Ansari, said.
The impact
The researchers assert that incorporating DTI limits, coupled with existing restrictions on Loan-to-Value (LTV) ratios, can serve as effective macroprudential tools. These tools, when synchronized, are believed to effectively mitigate systemic risks within the lending landscape, as highlighted in the RBI economists’ research paper.
Led by a well-diversified customer base displaying generally sound financial health, retail credit growth is currently robust. Despite this positive trend, the RBI economists emphasize the need for vigilant monitoring of the retail segment to identify any potential pockets of stress.
The underscores the importance for banks and financial service providers to continuously monitor the retail segment. This monitoring is deemed crucial to detect any undue build-up of stress and ensure the sustained health of the retail credit market.
The sustainability of the surge in retail credit flows is contingent on the health of two key sectors – households and financial service providers, including banks and non-bank financial corporations, as outlined in the study.
Additionally, the paper suggests the adoption of differential risk weights for various retail product classes, reflecting their inherent riskiness. The researchers advocate the utilization of emerging technology ecosystems, such as account aggregators, to enhance credit underwriting processes and strengthen the monitoring of lending models.
Despite a surge in growth, the study affirms the overall health of the retail loan portfolio across banks, product categories, and borrower risk classes. However, it does raise a cautionary note by identifying signs of weakness in certain subcategories within the unsecured retail sector, prompting a call for vigilant monitoring by lenders.
