Every bank wants it. They want to keep building it. They are thankful to this business for keeping them in good stead. But they don’t want to be seen supporting this product because it’s becoming a taboo in the market. We are talking about unsecured loans.

The risk of unsecured loans is understandable – higher defaults, the risk of lowering the benchmark on the credit history, and the likelyhood of inculcating a credit culture of overleveraging over the years. At the systemtic level, unsecured loans account for over a third of total retail loans. About a decade ago, they were less than a fourth of the total book. In that sense, the RBI is right in asking banks not to grow this business too much. But what can this intervention really achieve?

Banks’ profits

The rise of unsecured loans can be directly correlated to the profitability of banks. Margins of most private banks are upwards of 4 per cent. Some of them are on a mission to achieve 6 per cent threshold. Public sector banks are not far behind. They are kicking towards 4 per cent margins, almost two times more than what they used to make two years ago.

Clearly, unsecured loans seem to be the new game in the Indian banking arena. But is it a bad game? Globally, banks fail because books are built on loans without adequate collaterals. The Indian context, though, is still thankfully different. Over 70 per cent of unsecured loans are very granular and within the ₹1 lakh ticket size. So, if one should take a stand based on the macroeconomic outlook, a mass failure in the market is still a long shot.

Perhaps to that extent, the concern over unsecured loans is a bit blown out of proportion. But having said that, can banks and the regulator afford to reduce dependence on unsecured loans dramatically? After having tasted high yields and profitability, banks may be very reluctant to cede some of this cushion. Indian banks demonstrated resilience during Covid and were the first to report healthy financials since mid-FY21 thanks to the long rope handed out by the RBI since March 2020, including the freedom on product choices.

Resetting the rules

Now to slow down on unsecured products would place the system in a Catch-22 situation. Will the system be okay with lower bank credit growth? Will it be okay with lower profitability, and will asset quality levels remain the same, at a decadal low, if growth is to see a reset? To answer these questions, banks and the regulator must chart out how they retail lending pan out in the long run. If it’s just an opportunistic play, we may be nearing the peak. If not, now is the time to reset the rules, especially on unsecured loans.