Most of the bank loans are ‘secured,’ — they are backed by proper and adequate collaterals, because, to put it simply, if the borrower doesn’t repay the loan fully or partly despite all efforts by the bank, then the collateral can be sold to adjust the loan outstanding.

Unsecured loans (ULs) are those that are not backed by collateral.

Being riskier than the ‘Secured Loans” (SLs), banks give ULs to highly creditworthy borrowers and charge higher than the normal lending rates due to the additional risk involved as well as to mitigate the cost of extra capital (to risk-weighted assets) they have to maintain.

ULs are in the news recently because their ‘amount’ and ‘share’ in the total loans of banks are rising. News reports also say that RBI may tighten the norms for ULs to control their growth. However, commentators are highlighting ULs in the limited context of personal loans and credit card receivables, whereas the former can be for any purpose including even low-value consumer goods.

Further, the government allows collateral-free loans in respect of economically weaker or underprivileged sections of the society, e.g., education loans up to ₹4,00,000 (₹7,50,000 under the Credit Guarantee Fund Scheme for Education Loans — CGFSEL); loans to Micro, Small & Medium Enterprises below ₹10,00,000 and/or with guarantee from the Credit Guarantee Fund Trust for Micro and Small Enterprises; and retail microfinance.

It may also be noted here that not all credit cards are unsecured. Banks also issue ‘secured’ credit cards against financial security, preferably fixed deposit, with credit limit up to 90 per cent of its face value.

Current Indian Scene

Analysis of ULs by banks is constrained by paucity of data. Data on ULs published in bank balance sheets — the only source — is scanty. Based on balance sheets data, this piece focuses on the 2014- 2023 (March-end) period for analysis. Banks have been disaggregated into three groups — public sector banks (PSBs), old private banks (OPvBs) and new private banks (NPvBs). Table 1 presents the first set of results.

For all bank groups as well as bank group-wise, the amount of ULs and ULs/TLs ratio showed increasing trends. In aggregate, ULs posted a CAGR of 16.07 per cent with NPvBs leading at 24.31 per cent and followed by OPvBs (20.12 per cent) and PSBs (12.27 per cent).

The ULs/TLs ratio accelerated particularly 2015-16 onwards owing to several factors. The period coincided with acceleration of financial inclusion movement under the Pradhan Mantri Jan-Dhan Yojana; increased use of digital modes of payment, especially credit cards, in the post-demonetisation years; rejuvenation of microfinance after the 2010 crisis; launch of CGFSEL (credit guarantee fund for education funds) as mentioned earlier; competition with fintech growth; banks’ endeavour to protect or improve their net interest margin, especially when lending rates were low and secured credit was not taking off; relaxed loan regime in the aftermath of Covid-19, growing consumerism even in the rural areas owing to incremental income generation in general and Direct Benefit Transfer in particular.

The share of PSBs in the total ULs fell precipitously during the decade from 76 per cent to 56 per cent, and their loss was captured by NPBs whose share grew rapidly from 22 per cent to 40 per cent. However, in 2022 and 2023, PSBs gained and NPvBs lost some of their market shares. OPvBs remained marginal players.

Concluding Remarks

ULs need to be bridled. First, availability of easy loans potentially increases the indebtedness of the society at large. Second, if UL borrowers take loans, both secured and unsecured, from different lenders including private lenders, and if they face a financial crisis, then they will likely give priority to repayment of SLs or private loans. And, in case they default in repayment to any lender/s, it will likely be ‘contagious’ for other lenders.

In order to mitigate the contagion risk, banks giving ULs should see that the borrower has multiple relationships with the bank, especially as a depositor and as a borrower with multiple facilities. Further, borrowers should route their transactions through the deposit or loan account/s in the bank so that the bank can invoke ‘set-off’ clause in case of default.

Extreme caution, due diligence and rigorous follow-up are necessary for leashing ULs defaults. Besides, bank boards should fix the ULs targets judiciously.

Das is a former senior economist with SBI. Views expressed are personal.