RBI Governor red-flags personal loans, top-up lending, once again

Vinod Kothari (finserv@vinodkothari.com)

The RBI’s bi-monthly Monetary Policy review was accompanied by the Governor’s customary statement, dated 8^th August, 2024, highlighting 4 areas of potential risks to financial stability. Two of these relate to uncollateralised or personal lending.

The 4 red flags raised by the Governor are as follows.

First, with alternative financial instruments being available and attractive, lesser money is flowing into the banking system by way of deposits, thereby the credit-deposit ratio indicates deposit growth trailing the growth in credit. This would force banks to look for alternative short term sources of funding, to fund the credit growth, potentially creating what is known as structural liquidity risk. Structural liquidity risk is said to exist when there is greater dependence on short-term sources of funding, as compared to short-term assets.

It is notable that recently, the RBI proposed to increase the run-off rate for retail deposits which are backed by internet banking facility. Most retail deposits these days are. A higher run-off rate implies a faster ability of the depositor to withdraw his deposit, thereby increasing the assumption for outflows, which is used for computing the liquidity coverage ratio (LCR). Higher LCR requirement means higher funds blocked in so-called high-quality liquid assets, and thereby lesser funds available for lending. Thus, the Governor’s reference to slower deposit growth relative to lending will get be even stronger, once the proposed changes in LCR are implemented.

Second, the Governor highlights increase in personal lending. The statement specifically mentions growth in credit card outstandings. NBFCs are also mainly riding on the growth in personal loans.

Third point that the Governor makes is extremely important. This is about top-up lending. Top-up lending in case of home loans, known as home equity lending in the US market, came to the very core of the GFC. The Governor also mentioned about top up lending in case of other collateraliesd loans such as gold loans. The Governor sounded a note of caution: “It is noticed that the regulatory prescriptions relating to loan to value (LTV) ratio, risk weights and monitoring of end use of funds are not being strictly adhered to by certain entities”.

Top-up lending sometimes also exists in disguised form, with lenders taking a liberal view on the valuations of the underlying collateral. It is clear that in the highly competitive field of lending against homes and gold, the ability to lending more on the given asset is like the hand-waving Feng Shui toy used by most lenders.

The fourth point, of course, is technology dependence, with the recent outage of Microsoft services. There is very little anyone can do to avoid dependence on such concentric technology service providers, but the Governor advises  business continuity planning.