Mumbai: The Reserve Bank of India (RBI) will impose more regulatory curbs on unsecured lending if banks and finance companies do not mend their ways, it said in the Trends and Progress of Banking report published Thursday. The banking regulator also directed boards of lending entities to fix unsecured exposure levels prudently to prevent systemic risks.
The report also highlighted that banks’ profitability rose for the sixth consecutive year and gross bad loans were at a 13-year low in FY24. Still, the RBI expressed concerns over interconnectedness between lending entities and private credit firms, high attrition among private banks, liberal underwriting standards for top-up loans, and rising cyber frauds.
At the same time, it advised banks to fix the KYC gaps and closely monitor gold loans and hinted that it would issue directive to prohibit banks from charging pre-payment penalties on floating rate loans taken by small entrepreneurs. Although banks and finance companies have the discretion to set limits on unsecured exposures, “some entities have fixed very high ceilings, which need to be continuously monitored”, the RBI report said.
The regulator’s worries stem from the fact that even after it raised risk weightage on unsecured loans in November 2023, unsecured loans still constitute one-fourth of commercial banks’ books at the end of March 2024.
The RBI added it expects “boards of regulated entities (RE) to show prudence and avoid exuberance in the interest of their own financial health as also systemic financial stability”. Justifying its stance, RBI said that even though credit growth has dipped, “delinquency levels and leverage warrant enhanced vigil”.
On top-up loans, the RBI pointed out that lenders often sanction extra facilities to borrowers with minimal processes and due diligence, generously underwrite loans, follow inadequate fund end-use monitoring, and deviate from loan-to-value (LTV) ratios and risk weights.
“The RBI will assess the need, if any, for additional regulatory interventions to mitigate the identified risks in cases of other top-up loans,” said the regulator. The central bank also warned about malpractices in the digital lending scape wherein “unscrupulous players in digital lending space, who falsely claim association with RE. Enhanced monitoring and transparency are required.” To mitigate this risk, the RBI is in the process of setting up a repository of Digital Lending Apps.
On the interlinkage between banks, NBFCs and private credit, the RBI said: “Strong interrelationship between them could give rise to systemic concerns along with the possibility of regulatory arbitrage to circumvent regulations.” The regulator said close monitoring “is warranted as their reach expands beyond mid-sized corporate borrowers”.
The RBI said in its last October policy that it would restrict banks from charging prepayment penalties on floating rate loans of small businessmen to “safeguard customers’ interest”. At present, banks are not permitted to charge prepayment penalty to individual borrowers for purposes other than business. The RBI expressed concerns over high attrition in banks and finance companies, stating that “high attrition poses significant operational risks, including disruption in customer services and loss of institutional knowledge”.
KYC GAPS
It also directed banks to fix certain gaps in know-your-customer, or KYC processes. “Accounts getting frozen and lack of proactive customer assistance have caused operational inefficiencies and customer grievances,” the regulator said. The RBI advised banks to closely monitor gold loan portfolios as it continues to observe irregularities in lending processes.
