Suman Chowdhury’s Post

India's non-banking financial companies (NBFCs) are experiencing renewed stress, reminiscent of the challenges faced six years ago. Major NBFCs, such as Bajaj Finance and Shriram Finance, have reported increased delinquencies in unsecured loans, leading to higher provisions and reduced profits. The Reserve Bank of India (RBI) has expressed concerns over the aggressive growth strategies of some lenders. In response, the RBI has implemented measures to mitigate potential risks, including: Increased Risk Weights: The RBI raised the risk weights on unsecured personal loans and consumer durable loans from 100% to 125%, and on credit card loans from 125% to 150%. For NBFCs, the risk weights on unsecured personal loans, consumer durable loans, and credit cards were increased to 125% from 100%. Additionally, the risk weights on bank loans to NBFCs were hiked by 25 percentage points if the existing risk weight was below 100%. Regulatory Actions: The RBI has taken direct actions against certain NBFCs. For instance, Navi Finserv faced a ban on sanctioning and disbursing new loans due to "usurious" pricing practices. This ban was lifted after the company revamped its processes to comply with regulatory guidelines. Despite these measures, the NBFC sector continues to grapple with challenges. ICRA, a credit rating agency, anticipates that the gross non-performing assets (NPA) ratio for NBFCs will rise by 30-50 basis points in the current financial year, up from 2.8% in the previous year. The resurgence of stress in the NBFC sector underscores the importance of prudent lending practices and robust regulatory oversight to maintain financial stability.

RBI rings the alarm bells 🚨 for personal loan lending by Fintech!! RBI in it's Financial Stability report says "Delinquency levels among borrowers with personal loans below Rs 50,000 remain high. In particular, NBFC-Fintech lenders, which have the highest share in sanctioned and outstanding amounts, also have the second highest delinquency levels, only below that of small finance banks" Vintage delinquency, which is a measure of slippage, remained relatively high in personal loans at 8.2%. Little more than a half of the borrowers in this segment have three live loans at the time of origination and more than one-third of the borrowers have availed more than three loans in the last six months. The RBI noted that certain segments of consumer credit, esp. personal loans and credit cards pulled down the rate of growth in overall consumer credit. During April 2022 and March 2024, bank lending to the retail sector grew at a CAGR of 25.2% and lending to services - which includes bank lending to NBFCs - grew at 22.4%, far exceeding overall credit growth of 16.4%. The report elaborated on the red flags - rising stress in retail loans in private sector lenders.

Fixed And Floating Interest Rates In The Banking Sector Under the RBI’s extant instructions on interest rate on loans & advances, there are mainly three types of rates that the banks charged to their borrowers : 1. Base Rate 2. Marginal Cost Of Funds Based Lending Rate (MCLR) 3. External Benchmark Lending Rate (EBLR) 🟦 Base Rate The base rate is the minimum interest rate for loans enforced by the Reserve Bank of India before the emergence of the MCLR. The basis of the base rate depends on the average cost of funds. The operating expenses and the expenses to maintain cash reserve ratio are vital in determining the base rate. The base rate is not dependent on the changes made to the policy repo rate of the RBI. Banks can change the base rate on a quarterly basis. 🟦 Marginal Cost Based Lending Rate For all other types of loans (other than loans covered under EBLR), the banks are charging rate based on marginal cost of funds. The MCLR is the minimum interest rate a bank can charge for a loan. Banks are permitted to issue any category of loan on a fixed or floating interest rate under the MCLR regime. Therefore, for all loans linked to that benchmark, the bank will not lend at a rate that is lower than MCLR of that particular maturity. Cost of credit under MCLR comprises of following components : ▪️Marginal cost of funds : It shall comprise of marginal cost of borrowings and return on networth. ▪️Negative carry cost on account of cash reserve ratio (CRR) : Negative carry on the mandatory CRR [which arises due to return on CRR balances with the RBI by the banks being nil], is calculated as under : Required CRRx (marginal cost) /(1-CRR). ▪️Operative costs: All operating costs associated with providing the loan product including cost of raising funds shall be included under this head. ▪️Tenor Premium : These costs arise from loan commitments with longer tenor. The change in tenor premium should not be borrower specific or loan class specific. It should be uniform for all types of loans for a given residual tenor. ▪️Spread or Bank’s Margin ▪️Credit Risk Premium The interest rate given by a bank for deposits and borrowing are the decisive factors in the calculation of MCLR. 🟦External Benchmark Lending Rate Effective from Oct 1, 2019, the banks have been advised to charge EBLR (viz floating rate) for personal loan or retail loans ( housing, auto loans) and loans to micro and small enterprises. The EBLR can be linked to either of these rates : ➡️RBI’s policy repo rate (viz the rate on which the RBI lends funds to banks for overnight against collaterals), ➡️ 3months Treasury Bills Rate ➡️ 6 months Treasury Bills Rate ➡️ Any other rate published by Financial Benchmark India Pvt Ltd. EBLR = External Benchmark Rate+ Bank’s Spread or Margin + Credit Risk Premium + Billing and Settlement Plan (BSP) Current RBI Policy Repo Rate : 6.50% However, the banks are free to charge EBLR for other types of loans, if they so desire. Thanks for reading….

By way of an update, the Reserve Bank of India (RBI), on 26 April 2024, has issued the following notifications: a) Frequently asked questions on its Guidelines on Default Loss Guarantee (DLG) in Digital Lending dated 8 June 2023 (FAQs); and  b) Draft Guidelines on "Digital Lending - Transparency in Aggregation of Loan Products from Multiple Lenders" (Draft Loan Aggregation Guidelines). 1. Summary of FAQs: (a) The FAQs have now clarified that DLG cover can only consist of pre-identified and measurable loan assets that have been sanctioned by a lender (DLG Set). (b)The DLG cover should be specified upfront and remain fixed. (c)The DLG cover would be calculated on the amount of loans disbursed proportionally under a DLG Set at any given point of time. (d) No Replenishment of the DLG cover in case of subsequent recovery. (e) As per the FAQs, DLG is not permitted for revolving credit facilities.   (f) Miscellaneous: (i) DLG is not permitted for loans arranged on peer-to-peer lending platforms. (ii)The DLG guidelines would not be applicable on loans sourced outside the Digital Lending Guidelines. (iii)DLG arrangements cannot be entered into for financing availed through credit cards. (iv) Lending services providers (LSPs) must publish the total number of portfolios and respective amounts of each portfolio on which DLG has been offered. The FAQs have further clarified that the name of the RE can be omitted from such disclosure requirements.  (v) The DLG Guidelines require a declaration from the statutory auditor of the DLG provider every time they enter into an arrangement with an RE. The FAQs clarify that no such declaration is needed from the statutory auditor of the RE to whom the DLG is being provided. (vi) The RBI has also prescribed the below additional requirements to be followed by REs acting as DLG providers. This includes that the RE should deduct full amount of the outstanding DLG from its capital. REs acting as DLG providers should have a board-approved policy in place as a best practice.   2. Summary of the Draft Loan Aggregation Guidelines. The Guidelines have been issued to promote ‘customer centricity’ and ensuring ‘complete transparency’ to the borrowers in the credit intermediation process. In cases, where loan product aggregation services are offered by many LSPs through outsourcing arrangements with multiple lenders, and the digital lending application (DLA) of the LSP / RE for matching its customers to one of the lenders, REs are advised to ensure that its LSPs comply with the guidelines.The LSP should provide a digital view of all loan offers available to the borrower from willing lenders with whom the LSP has arrangements.   The aforesaid changes impact operations of LSPs who source borrowers for multiple REs as they will have to restructure their loan offering to ensure uniform treatment for all such REs. The Draft Loan Aggregation Guidelines are open for public comments till 31 May 2024. #fintech#digitallending#LSP#RBIupdate

Fitch Ratings warns that rising stress in unsecured retail loans may challenge Indian #banks' asset quality in 2025 — and adds that despite an overall decline in the sector's impaired-loan ratio, new bad loans could see a notable rise Asmita Pant

Bank lending and deposits increased at the same pace by 11.5 percent as of December 20. However, both credit and deposit growth have slowed compared to last years figures. Retail loans remained a key contributor to credit growth, while term deposits...

At least 3 Quarters from closure of the Retail Unsecured Loan Misadventure We are at least three quarters away from the lending sector fully provisioning the damages from the retail unsecured loan mania. Longer, if the economy continues to be in a funk. Bad news from the MSME unsecured segment has just started coming in. First step is recognising the problem (the PD dimension).  Next, recognising the extent of the problem (the LGD dimension). Because banks provision using the RBI’s IRAC norms unlike the NBFCs, the NBFCs will bottom out sooner than banks. Had RBI implemented ECL norms for banks, the timeline of the crisis could have been crunched and hence the next credit cycle could have commenced sooner. A lot of finger pointing will happen over the next few quarters. You will see more frequently auditors use the expression “Emphasis of the Matter” in the Independent Auditor's Reports in the context of loan provisions. While there were significant frauds during the unsecured loan mania, not everything was a fraud and one should never attribute to malice what can adequately be explained by stupidity.  RBI and SEBI, in the interest of the greater good of the fixed income markets, should make an example out of some of the egregiously bad actors by preforming the famous Chinese manoeuvre to "kill the chicken to scare the monkeys” Most Bank/NBFC analysts were cheerleaders by coming up with absurd stock price targets that ignored the underlying assets. In my note in early October, I had recommended subjecting the analysts to the “Pons asinorum” test (“Net Interest Margin (NIM), Bank Analysts and the ‘pons asinorum’ test”).  Hopefully the analysts would do an honest self-appraisal while getting ready for the next cycle.  They should not be shy about doing a little reading and learning about the sector they cover – it will certainly not hurt them. Book recommendation: The Great Crash 1929 by John Kenneth Galbraith (US ambassador to India between 1961 and 1963)

Unsecured Retail loans....the story so far (Part 3) - continuation of Part 1 and 2 8) Refinancing is at the heart of the unsecured loan mania. This has led to a paradox - banks are reporting lower level of stress in their unsecured portfolio than their secured loan portfolio. Is it not funny that a bank should have lower level of SMA1, SMA2 and NPA in its unsecured portfolio than its home loan portfolio? 9) Though delayed, the RBI's December 2023 strictures brought some sanity to the retail unsecured loan market. To summarise: a) RBI increased the risk weight for retail unsecured lending b) RBI has discouraged bank lending to NBFCs/Fintechs by linking risk weight of such lending to the credit rating of those companies 10) There has been some effort by some NBFCs/Fintechs to pass off quasi unsecured loans as fake gold loans. Fortunately the RBI has been at the top of its game and has come heavily on some rogue NBFCs. .....to be continued

The last Shoe to drop in the Retail Unsecured Loan Saga After the Q2FY25 results of the lending sector, investors have been excessively focused on retail unsecured loan defaults at listed entities (banks and NBFCs). The far bigger problem is the mind-boggling scale of defaults at unlisted fintechs and microfinance companies.  The next shoe to drop is when these entities default on their borrowings from banks, SFBs and big NBFCs.  Analysts should check how much exposure these listed entities have to NBFCs (fintechs and microfinance companies) under the category of loans to corporates.   In my note “The Granger Causality Test and forecasting System-wide Credit Stress”, I had chronicled the likely chronology of the unsecured sage- extract from that note is given below: “The Granger causality test can be used to predict impending system wide credit stress. The Granger causality test is a statistical test for determining whether one time series is useful for forecasting another. It was first proposed by Clive Granger, a Nobel laureate in Economics.  The search is for the variable X that precedes Y and hence can be used to forecast that Y will likely happen.  “Sharp decline in system credit growth (X) is an early sign of impending system credit stress (Y). When rate of credit growth shrinks, the borrowers of marginal credit quality will find it hard to rollover their loans or get new loans. While I have been predicting gloom and doom of unsecured retail loans since September 2023, the chronology of the retail unsecured loans saga is follows 1) RBI raised Risk weights for such loans in December 2023 2) Causing banks to cut the growth of unsecured retail credit in March 2024 3) Causing bad loans at microfinance companies and fintechs in June 2024 4) Likely causing the crisis to spread to banks and SFBs in September 2024 and 5) perhaps a full blown unsecured retail credit crisis by December 2024”.

VR/14/2024-SC-MSMEs Vs Banks/NBFCs The Supreme Court has come to the rescue of MSMEs in its judgment of 01.08.2024. On 29.05.2015, Ministry of Micro, Small and Medium Enterprises issued a circular, containing the “Framework for Revival and Rehabilitation of MSMEs”. (“GOI Circular”). Under the Circular, Banks/Creditors of MSMEs are required to identify incipient stress in the loan accounts of MSMEs by creating three sub-categories of such stress loan accounts (Special Mention Accounts, i.e., SMA-0, SMA-1 and SMA-2, depending on the level of stress the borrower is facing.  The lenders are required to form a committee, which is accessible to the borrowers and can work along with them on a corrective action to improve their situation. By then, there were existing guidelines issued by RBI to banks titled “The Banks/Creditors Income Recognition, Asset Classification and Provisioning Pertaining to Advances”. (“RBI Guidelines”) In view of the GOI Circular, RBI sent a communication to all Scheduled Commercial Banks, making certain changes to RBI Guidelines, to ensure that they are compatible with the GOI Circular. Under GOI Circular, the Banks are required to identify stressed loan accounts and classify them as one of the three SMA categories. GOI Circular also allows the borrower to voluntarily apply for classification of its account as SMA. In such case, the account shall first be classified as SMA-0. In this scenario, some Banks have gone ahead and taken action against some MSME borrowers under SARFAESI Act, without following the GOI Circular or RBI Guidelines. This action was challenged by some borrowers in a batch of Writ Petitions before Bombay High Court. The High Court dismissed the Writ Petitions on the ground that the instructions contained in GOI Circular were not mandatory. The borrowers approached the Supreme Court and the Supreme Court has set aside the decision of Bombay High Court. Some of the findings of the Supreme Court are under: a)    RBI Guidelines have statutory force and compliance with them is mandatory and not optional for banks, in view of section 21 and 35A the Banking Regulation Act. (para 13 & 18) b)    The provisions of SARFAESI Act have overriding effect. However, SARFAESI Act would come into play, only after the borrowers’ accounts are declared NPAs, which shall be only after the GOI Circular and RBI Guidelines are followed. (para 14) c)    When Banks declare a borrower’s account as NPA, it is also the responsibility of borrowers to inform the Banks about the due process to be followed and question such action. In this case, the Banks have already completed the process under SARFAESI and taken possession of the properties. Therefore, the cases are not remanded back to High Court. However, as the High Court has not dealt with the factual issues, the borrowers are free to take recourse to any legal remedy. (para 19).