By NR Bhusnurmath
The Reserve Bank of India’s (RBI) tighter scrutiny of the credit card industry (recently, it asked Federal Bank and South Indian Bank to stop issuing new co-branded credit cards) is of a piece with its angst about the huge run-up in unsecured retail loans. From a time, not so long ago, when banks almost never gave unsecured loans, least of all to individuals, today we are in a situation where banks and non-banking finance companies (NBFCs) are vying with each other for lending to individuals, many of whom have no credit history, and often without even the most cursory of credit appraisals.
What has changed? For answers, rewind to soon after the asset quality review undertaken during the tenure of former RBI governor Raghuram Rajan and the ensuing crackdown. Spooked by subsequent events that saw regulators and investigative agencies come down on hapless bankers, especially in public sector banks, the latter began to follow the lead of their private sector counterparts: shun large corporates and focus, instead, on retail loans.
In contrast to loans to corporates, retail loans have many advantages: Amounts involved are relatively small, defaults tend to be the exception rather than the rule (though this has since changed with the rampant increase in loans, often to the sub-prime), and best of all, individual borrowers seldom have political clout of the kind corporates possess that often stymies recovery.
Come Covid, and the combination of a dip in economic activity and reluctance of large corporates to borrow and banks to lend to them meant there were few takers for corporate credit. Meanwhile, demand for individual consumption loans, led by fall in incomes and rock-bottom interest rates, skyrocketed.
The net result has been a sharp increase in the personal loan portfolio of banks. In the April-February 2023-24 period banks’ personal loan portfolio has grown nearly `11 trillion to approximately `53 trillion, accounting for a third of the total bank credit of `162 trillion. Within the category of retail loans, credit cards are the most ubiquitous and simplest kind of retail loan.
Any credit card holder can freely avail of almost a month of credit without any documentation or scrutiny. With more than one credit card it is possible to juggle dues so that the credit period is elongated. And provided the holder is smart enough to pay dues on time, she can enjoy a loan that is almost interest-free.
Customers called ‘revolvers’ borrow regularly on their credit cards and avoid repayment of these loans by using the facility to pay the minimum amount. Though the cost of rolling over the loans is very high for the borrower, card issuers are happy since the return from these card dues is very high.
It is no surprise, therefore, that card issuance and spending shot up. As of February 2024, the number of credit cards in circulation is estimated at 100 million, up from 97.9 million in December 2023 of which co-branded credit cards reportedly constituted 10-15%.
Understandably, the RBI is concerned. Though credit card exposures generate high returns since the interest rate on these outstanding amounts is much higher than that on loans, they are very risky as they are, typically, extended to customers who are unlikely to get credit from banks at a lower cost. In the case of Korea, for instance, a Bank of International Settlements paper, Credit card lending distress in Korea by Taesoo Kang and Guonan Ma, found that a massive credit card lending boom in 2003 was followed by a wrenching bust. Many credit card issuers were on the brink of collapse as they struggled with deteriorating asset quality and difficult liquidity and solvency challenges, which in turn exposed the banking sector and financial markets to systemic risk and severely affected the real economy.
Weaker corporate loan demand, ample liquidity in the banking system, and lower interest rates in the wake of the Asian financial crisis put pressure on banks and other lenders to focus more on consumer lending. Commercial banks in Korea financed not only their own credit card operations but also provided loans to the dominant monoline credit card issuers. Their study also revealed that a disproportionate share of loans went to the least creditworthy borrowers.
In another paper, Dell’Ariccia and Robert Marquez (2006) found that new players intensified competition among credit card issuers for market share, leading to the relaxation of lending standards in pursuit of stronger credit expansion.
NBFCs issuing credit cards may face stability issues if defaults increase dramatically. However, it is important to distinguish between risks at the micro and at the macro (systemic?) levels. While individual NBFCs must be left free to determine their own risk appetite and face the consequences of unbridled growth, at the macro level, the RBI has reason to be concerned, especially if the spurt in credit card outstanding relates to banks which issue their cards through their subsidiaries. Such NBFC subsidiaries are subject to much less stringent oversight from the RBI and hence could have unrealistic risk appetites. But the collapse of these subsidiaries will impact their parent banks.
The only answer is to ring-fence banks via the holding company model suggested by numerous expert committees in the past, starting with the then RBI deputy governor, Anand Sinha, in May 2011. Ring-fencing banking operations from operations of other group companies will mean both card-issuing and other NBFCs are owned by the holding company and not the bank. In such a scenario, problems of an NBFC would not affect the bank and financial stability will not be endangered.
NR Bhusnurmath, Adjunct professor, Institute of Management Technology, Ghaziabad. Views are personal