MUMBAI: The Reserve Bank of India (RBI) flagged concerns about the unchecked growth of unsecured loans, which still constitute one-fourth of commercial banks’ books at the end of March 2024, despite the regulator’s move to raise risk weightage on such loans in November 2023.
“Raising the risk weightage on unsecured loans failed to check the proliferation of such loans,” the RBI observed in its Trends and Progress of Banking report released Thursday.
The central bank warned that it would impose additional regulatory curbs if banks and finance companies fail to manage their unsecured exposure levels prudently. It also urged boards of lending entities to exercise caution and fix prudent ceilings to mitigate systemic risks.
While banks’ profitability improved for the sixth consecutive year and gross bad loans were at a 13-year low in FY24, the RBI cautioned against complacency. “Delinquency levels and leverage warrant enhanced vigilance,” the report noted, adding that exuberant lending practices could undermine financial stability.
Concerns over top-up loans
The report criticised lax underwriting standards for top-up loans, highlighting practices such as inadequate monitoring of fund usage and deviations from loan-to-value (LTV) ratios. The RBI warned that it would assess the need for further interventions to address these risks.
It also flagged malpractices in the digital lending space, where some entities falsely claim association with regulated lenders. To curb such risks, the RBI is establishing a repository of digital lending apps to enhance transparency and monitoring.
Interconnectedness
The RBI expressed concerns about the strong interrelationship between banks, NBFCs, and private credit firms, warning that such interconnectedness could lead to systemic risks and regulatory arbitrage.
The regulator stressed the need for close monitoring as these entities expand their reach beyond mid-sized corporate borrowers.
Additionally, high attrition rates in banks and NBFCs were flagged as a significant operational risk, leading to potential disruptions in customer service and the loss of institutional knowledge.
Focus on KYC, gold loans
The report identified gaps in know-your-customer (KYC) processes, with accounts being frozen and customers receiving inadequate assistance. It directed banks to rectify these issues to improve customer experience. It also advised close monitoring of gold loans to ensure compliance with regulations.
The RBI reiterated its intent to prohibit banks from charging prepayment penalties on floating rate loans for small entrepreneurs, safeguarding customer interests. Currently, banks are already barred from levying such penalties on individual borrowers for non-business purposes.
The regulator called on banks and NBFCs to adopt stricter risk management practices and avoid exuberant lending to protect their financial health and the broader stability of the financial system.
“Boards of regulated entities must show prudence and avoid exuberance in the interest of systemic financial stability,” the RBI stated, signaling that failure to heed this warning could invite more stringent regulations.
