Banks face rising defaults from retail loan borrowers

MUMBAI: Non-performing assets (NPAs) from retail loans of commercial banks are set to rise, according to a recent report by ratings firm Crisil.

In its report released in Mumbai on Tuesday, Crisil has said that gross NPAs in retail loans are set to rise to 4% over the next two years from 2.7% as of March 2007-end. Delinquencies across all retail asset categories have gone up and are likely to further increase in 2008-09.

The recent move by the central bank to tighten the norms for recovery agents employed by commercial banks could also add to NPAs as it could further encourage wilful defaults by borrowers.

However, the situation will remain manageable, because the less risky mortgage and vehicle loan segments continue to dominate the retail lending portfolio of lenders at 80% of total loans outstanding. Further, rising personal incomes and younger borrower profiles provide cushion in mortgage loans.

Bank profitability is also expected to be hit this year on account of higher provisioning by banks as also rising deposit costs, according to Tarun Bhatia, head, corporate & government ratings, Crisil. This could be marginally offset by banks booking treasury profits from bond sales since yields are seen moving southward.

According to Crisil’s analysis, there has been some deterioration in retail loans because of increasing exposure to higher risk customers and rising interest rates. The increasing exposure to higher risk customers is mainly through personal loans and credit card receivables.

These are essentially unsecured loans and account for 17% of total outstanding retail loans in March 2007, up from 6% in 2004. As competition has increased, players in retail lending, in their quest for growth and higher profits are reaching out to newer clients such as the self-employed and borrowers from smaller cities, Crisil report said.

The Crisil report has noted that delinquencies across all asset classes have gone up and this trend is likely to continue in FY09 as well. Gross NPAs from home loans that account for half the retail loans in India have gone up from 1.8% in FY05 to 2.2% in FY07 and are further expected to go up to 2.7% in FY09. NPAs in auto loans, accounting for a third of retail loans are expected to go up by 70 to 150 basis points in FY08.

Delinquencies have gone up sharply in September-October 2007 because of the slowdown in recovery efforts, following the controversy over recovery methods used by some lenders. A possible fallout of this controversy could be that some players exit the small-ticket personal loan segment, which has been most affected. And this could drive lower income borrowers to seek recourse to money lenders, which will be detrimental to the policy goal of seeking larger financial inclusion.

Another possible outcome could be an increase in wilful defaults by borrowers. The ratings agency has underscored the need to educate borrowers about the importance of financial planning and the need to repay loans.

Crisil has come out with its own definition of ‘subprime’ in the Indian context and this includes small-ticket personal loans and a portion of credit card receivables. These loans are typically given to low-income customers.

Going by this definition, ‘subprime’ assets in India are still relatively low at 7% of total outstanding retail loans. Crisil estimates the loss levels in this segment to be currently at 7-9%, and expects them to increase to 10-13% over the medium term.