Navigating the Tightrope: India's Credit Market

Throughout my career in banking and VC, I have made slides depicting credit under-penetration in India - numbers like <5% credit card penetration, ~550M unserved + underserved customers - showing the massive untapped potential for Indian Fintechs. However, in a surprising twist, the Reserve Bank of India (RBI) tightened the reins on consumer credit by increasing risk weights1 in Nov'23. They specifically cautioned against increasing exposure of banks and NBFCs to unsecured consumer credit.

The question needs to be asked - is the RBI being conservative? Why curb the flow of credit in a country that's credit starved?? A deeper exploration reveals the intricate balance between fostering financial inclusion and averting systemic risks.?

(1Risk weight: Risk-weights are used to determine the minimum amount of capital a bank must hold in relation to the risk profile of its lending activities. Increasing risk weights causes banks to hold more capital for each rupee lent, thus increasing the cost of borrowing)

Growth of Unsecured Consumer Credit: The Fintech Revolution

1. Personal loans witnessed high growth in 2023 (~29% y-o-y) with increasing share of Fintechs / NBFCs?

Be it BNPL, prepaid credit instruments (Slice, Uni) or any other personal loan products, Fintechs in partnership with NBFCs have increased reach while reducing cost of distribution. A direct consequence is increase in originations (number of loans applied) through Fintechs + NBFCs which is currently at 80% of overall originations. These loans are largely low ticket personal loans with ticket size less than INR 1 Lac.?

Due to higher originations, the share of NBFCs has been growing steadily and is currently at 54% by volume, 20% by value.

2. Exuberant growth in Credit Cards led by co-brands

While Fintechs are dominant in personal loans, consumer tech brands have spurred the growth in cards through co-brands. On an average ~1-1.5M cards are getting issued per month with private banks like HDFC, ICICI, Axis dominating the new issuance (~80%). The Amazon-ICICI (4.5M user base), Flipkart-Axis (3.2M+ active), Tata Neu-HDFC (1M+ user base) cards are particularly popular and are helping banks tap into higher spends and reach new customer segments. This has resulted in 30%+ growth (y-o-y) in credit balance outstanding with higher PAR 302 at 3.6% (v/s 3.4% in FY22), indicating early signs of stress.?

(2PAR 30 is % loan portfolio that is overdue beyond 30 days. It is a measure of default risk in a loan portfolio)

RBI’s Prudent Pause

The burgeoning growth in retail credit, while impressive, has not been without its concerns. The RBI's decision to increase risk weights stems from an awareness of the potential perils of unchecked credit expansion, especially within the unsecured segment

1. Over exposure to unsecured credit

Growth in unsecured retail loans has been rapid over the last 2-3 years, its share growing to 10.6% in Jun’23. Such drastic changes in the portfolio composition can expose the banks to unknown risks. RBI started noticing some stress in the unsecured portfolio in Oct '23, where loans were being given out to customers with significant overdues. This was seen as an early warning signal to imminent defaults

2. Growth in low ticket loans where collections capabilities are under-developed

Some interesting characteristics of the current growth in unsecured portfolio –?

• 80%+ loans originated are low ticket size (<INR 1 Lac) and come through NBFCs / Fintechs
• Growth is mainly from New to Credit (NTC) and subprime segment where borrowers have weaker credit profiles
• Collections is not cost effective given the ticket size and hence the capability is under-developed

3. Lessons from global crises

Any stress in the economy (inflation, job loss) can lead to mass default in the sub-prime/ NTC customer segment and cause a ripple effect on the entire banking ecosystem (think of the 2008 mortgage crisis where subprime customers defaulted on housing loans). By tightening the controls on retail credit, the RBI aims to pre-emptively curb the associated risks, drawing lessons from international precedents to avoid a similar fate.

Opportunities in secured lending

Amidst the tightening landscape of unsecured lending lies a silver lining - the untapped potential within the secured lending segment

1. Loan against securities / assets?

If one leaves out the top 40M-50M customers of credit who are very well served, there are many who are not eligible for credit cards or personal loans. However, they have assets in the form of (a) Fixed Deposits, (b) Mutual Fund / Stocks or (c) an LIC policy. While Gold Loans have been very popular in India (think Muthoot, Manappuram), any other form of pledging has not scaled well, due to the absence of an easy way to collateralize the assets.?

With increasing penetration of mutual funds, digitization of assets like LIC policy, and availability of data through Account Aggregator (AA), there is a huge scope for startups to innovate especially on infrastructure and distribution. Founders need to solve for a seamless customer experience while providing lenders with complete visibility of the asset.?

2. Home Loans and Loan Against Property (LAP)

The process of getting a home loan today and managing it is quite broken. The idea of approaching 10 different banks with multiple sets of documents, understanding the terms (along with the fine print), and negotiating rates is not only cumbersome but also completely offline. With land records getting digitized and customer data available through AA, the entire process or at least a significant part can be shifted online.

There are multiple opportunities that can be explored once you have acquired the customer and have digital records of the property. A few that are top of mind are (a) Balance Transfer, (b) LAP, (c) Top-up loans, etc.? This is a very large profit pool waiting for disruption.

Conclusion

The recent developments in India's credit market serve as a reminder of the fine line between financial inclusion and ensuring systemic stability. While there might be some headwinds for growth of unsecured credit in the short term, the measures will help build a healthy ecosystem. There continues to be tremendous potential in the secured lending space with opportunities for Fintechs to tap into asset bases that have been previously unexplored.

If you have views on Fintech opportunities, are a Fintech enthusiast or a founder trying to build in the space, would love to hear your views. Do reach out at [email protected].