Opinion
A ritualistic risk dance begins as the political stakes start to rise
Summary
- RBI’s belated tightening of personal-loan rules suggests that regulatory checks remain tied to the Indian electoral calendar. Authorities seem to be comfortable with excessive speculation during normal times but acquire jitters just before polls.
There are no prizes for guessing when it’s election time in India; the high-decibel festive atmosphere accompanying pre-election campaigning makes sure that polls never go unnoticed. But there is another pre-election event that is also a clear giveaway: a sudden tightening of rules in the financial markets. Nobody wants a scam or payments crisis before key elections, especially one that may spring up in capital markets and traverse the financial system.
The recent risk-mitigation measures announced by the Reserve Bank of India (RBI), imposing constraints on the growing volume of loans given to individuals, probably falls in the same category. RBI’s rear-guard action is aimed at minimizing risk from burgeoning unsecured personal loans advanced by both banks and non-banking financial companies (NBFCs). However, this cautionary move also seems counter-intuitive, given that RBI’s recent economic bulletins have been exceedingly bullish about the economy’s near-term growth prospects but completely silent about any potential risks.
So, under which rock did the central bank discover these hidden risks? Read on.
The Indian central bank has increased the risk weightage for personal loans—outstanding as well as new loans—advanced by banks and NBFCs. Consequently, lenders will now need additional capital if they want to keep pushing the consumer credit pedal, or will have to reduce their exposure over time. Interestingly, the higher risk weightage applies only to general purpose consumer credit and not to loans with specific end-uses, such as loans for housing, car purchases, educational purposes or loans taken against bullion or jewellery. In NBFCs, microfinance or self-help group loans have also been excluded. Even bank loans to NBFCs face an increase in risk weightage, making NBFC on-lending to retail customers more expensive. In short, all unsecured lending to individuals is now deemed a greater risk.
The new measures come on top of RBI’s latest warnings. Governor Shaktikanta Das articulated his apprehensions during the October monetary policy review: “Certain components of personal loans are, however, recording very high growth. These are being closely monitored by the Reserve Bank for any signs of incipient stress." The minutes of the monetary policy committee meeting also reveal member Ashima Goyal advocating caution: “Indian household debt is low by international standards, but a sudden rise can be a concern. It is best to restrain over-enthusiasm in good times and thus avoid a crash. Prudential tightening… would be preferable to raising policy rates more."
But all this does raise doubts whether these warnings and alerts are timely. Personal loans as a category have demonstrated sharp growth over the past two years, racing past growth in overall credit demand. Personal loans grew over 41% in the 24 months to 22 September 2023. During this time, overall credit grew by 32%. Reading the central bank’s economic commentary during this period, readers would never have guessed that something risky was brewing under the surface. Even external voices of moderation were discounted.
RBI’s anxieties, as the new rules now clearly illustrate, emanate from loans without any specific end-use, in particular the sub-category ‘Other Personal Loans’: after housing loans (which account for almost 50% of all personal loans), this sub-category comes second with a contribution of almost 28%. This substantial chunk of personal loans is unsecured and with no regulatory line of sight into its end-use. After adding advances against fixed deposits and other similar loans, the non-specific loan categories amount to around 33% of all personal loans.
But signs of incipient risk have been lurking in plain sight. It has long been suspected that a large chunk of this money has been used for speculative trades in the equity derivatives markets. A whole new generation of fintech firms has sprung up to facilitate retail speculation in derivatives in the name of innovative investing.
Consider the data. Total turnover in the equity derivatives market jumped 70% between January and September 2023. Options trading in shares, specifically, has jumped 51% during this period. Froth in the derivatives market even prompted the National Stock Exchange to caution retail investors from indulging in derivatives speculation. The Securities and Exchange Board of India has not issued any warnings yet, though media leaks suggest it may be planning to come out with some rules.
Money being fungible, there is no definitive proof that retail borrowers have been diverting unsecured loans for speculative derivatives trading. But regulators have identified retail speculators behind the spurt in derivatives trading volumes. It therefore stands to reason that this class of investors, loath to divert their own savings for speculative operations, would have instead opted for unsecured personal loans.
This is not the first time that authorities have become conscious, just before elections, of elevated risks spilling from one market to another. One recent example is the belated introduction of physical settlement for individual stock futures in 2018, a good 17 years after the product was launched but just before the 2019 general elections. But it does point to an uncomfortable fact: authorities and regulators seem comfortable with excessive speculation during normal times but acquire jitters just before elections.
