Shadow Lenders in India: Navigating Rising Bad Loans Amid Regulatory Scrutiny
India's shadow banking sector, known for its crucial role in reaching "no file" and "thin file" borrowers, is facing a challenging period of retreat and restructuring.
As non-banking financial companies (NBFCs) confront increasing loan delinquencies and stricter oversight from the Reserve Bank of India (RBI), the sector’s expansion is showing signs of stress. Six years after the shadow-banking crisis, pressures are once again mounting, with several prominent players adjusting their lending strategies to manage risk.
The Essential Role of Shadow Lenders for Underserved Borrowers
Shadow lenders play a significant role in India’s financial ecosystem by extending credit to individuals and small businesses who often lack comprehensive credit histories. This includes no-file and thin-file borrowers, such as gig economy workers, small entrepreneurs, and individuals with limited formal employment records. NBFCs like Bajaj Finance, Shriram Finance, Mahindra & Mahindra Financial Services, and IIFL Finance have developed business models that assess alternative credit data, allowing them to serve segments overlooked by traditional banks.
However, their focus on high-yield unsecured loans comes with added risks. With rising defaults, these institutions are now facing pressure to reevaluate their lending practices and manage exposure to vulnerable customer segments.
Increasing Loan Delinquencies and Tightening Provisions
In their recent earnings reports, major NBFCs posted an uptick in bad loans on unsecured loan portfolios, coupled with lower-than-expected profits due to increased provisioning. For instance, Bajaj Finance has started limiting the number of clients with multiple loans, a response to rising delinquencies. Likewise, Axis Bank has reduced its disbursements on unsecured products, signaling a broader retreat from high-risk segments. This shift highlights a broader trend as lenders recalibrate their portfolios to manage growing losses.
The financial impact is tangible. Data from the RBI shows that NBFCs held 15% of assets within India’s financial system as of March 2023. While these institutions achieve profitability through higher interest rates, their exposure to defaults becomes more pronounced during economic downturns.
As per Moody’s, shadow lenders are especially vulnerable when economic cycles shift unfavorably.
Regulatory Tightening: Striking a Balance Between Growth and Prudence
The RBI has been vocal about its concerns regarding the “growth-at-any-cost” approach that some NBFCs have adopted. To curb excessive risk-taking, the central bank has imposed new regulations, including heightened capital buffers for consumer loans and increased risk weightings on NBFC exposures. In recent months, the RBI has even restricted four shadow lenders from issuing new loans due to concerns about unsustainable growth and balance-sheet risk.
These regulatory measures aim to foster a more prudent lending environment and prevent a repeat of the 2018 shadow-banking crisis, which saw the collapse of Infrastructure Leasing & Financial Services (IL&FS) and exposed systemic vulnerabilities in India’s financial sector. It has been observed that without the RBI’s intervention last November, the situation could have escalated further. I believe that scaling back exposure to high-risk unsecured loans is essential for maintaining stability.
Slower Asset Growth Forecasted Amid Tightening Capital
Following a period of rapid expansion, asset growth for shadow lenders is expected to decelerate.
ICRA projects that NBFC asset growth will slow to 16-18% in FY 2024-25, down from 25% the previous fiscal year.
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This retreat is driven not only by regulatory pressure but also by the challenging economic environment, marked by tighter liquidity and increased competition for deposits.
The sector’s response has been to tighten underwriting standards, especially in high-risk segments like credit card loans, personal loans, and microfinance portfolios.
In my opinion, rising defaults can be partly attributed to over-leveraged consumers who took personal loans to meet consumption needs they could not afford with their limited incomes.
The Impact on India’s Consumption-Driven Economy
This cautious shift among shadow lenders is likely to impact India’s broader consumption-driven economy. Consumption-related credit products, such as credit cards and consumer durable loans, are seeing reduced capital flow as NBFCs and banks respond to stricter capital requirements and the rising default risk. This contraction in credit availability could dampen demand for consumer goods, slowing economic growth.
Data from TransUnion CIBIL indicates that firms have raised underwriting standards to address rising bad loans.
Additionally, as individual credit growth has moderated from 19.3% last year to 12.8% as of October 25, the availability of credit for consumers has become increasingly constrained.
The Path Forward: Prudent Growth and Enhanced Risk Management
Moving forward, shadow lenders in India are expected to adopt a more measured approach, emphasizing stronger risk assessment and prudent capital allocation. This shift is necessary to manage rising defaults while safeguarding against future crises. Improved underwriting standards and more conservative lending practices will be vital to maintain financial stability within the sector.
Despite these headwinds, India’s economy remains resilient.
HSBC’s recent survey on India’s Purchasing Managers’ Index (PMI) for services showed a positive outlook, with October’s index at 58.5, indicating sustained growth in the services sector.
A recovery in export sales across sectors, as well as job creation driven by strong domestic and international demand, suggests continued economic momentum.
In my opinion, while input price inflation is a concern, the overall inflation trajectory remains below the long-run average. This indicates a supportive macroeconomic environment, albeit with cautionary signs in the credit sector.
Conclusion
As shadow lenders adjust to increased regulatory oversight and heightened credit risk, the sector faces a pivotal moment. By prioritizing risk management and more conservative lending, NBFCs can contribute to financial stability while still supporting India’s underserved borrowers. This cautious approach may ultimately strengthen the shadow banking sector, ensuring that it remains a vital component of India’s financial landscape, albeit with a sharper focus on sustainability and prudence.
Security Operations |Fintech |Risk Management |Governance l App Sec #viewsarepersonal #apolitical
2wWonderfully summed up sir. Rather than working around the solutions on handling delinquencies , under writing and prudential lending standards require revisit for the NBFCs. NBFCs, fintech platforms and Banking Correspondents need special and mostly a non intrusive regular monitoring to address the risks. After the IL&FS shocker the regulation of NBFCs has been transferred to RBI and we believe a differential , tech driven and risk centric approach which RBI has adopted will create institutions which can withstand headwinds, survive and flourish.
Retired Deputy General Manager at State Bank of India having 30 years of experience
2wVery informative Sir
Empowering Sales & Marketing with NBFC Setup and Risk Underwriting Expertise
1moGreat insights, Ram! Your analysis of the shadow banking sector's challenges and the critical role of NBFCs in fostering financial inclusion brings much-needed clarity to this complex topic. It's essential to approach these changes with a focus on sustainability. Thank you for shedding light on this important issue.
Co-founder & Director-ASTER Associates Consultants, Invest. Bkg. Advisory on M&A, JVs, Tech.Transfer, Project Finance, Co-founder & Director-NOVELL Associates. Coordinator-Business Strategy & Marketing at VASTAV Group
1moSir, while we concur with your views, have appended a few facts below...... In a growing environment like ours, there is a constant need to adopt a 'Risk Based approach' by the lenders. Evaluation of repayment capacity of the borrower is of immense importance to avoid any delays/defaults in repayment by borrowers. However, there is also a need to redefine and streamline the 'Collection, Recovery and NPA' strategy by the lenders. This is mainly since, in today's competitive and complex business environment it is challenging for SMEs/MSMEs and Start Ups, to survive, consolidate and grow.....
Retired Banker | Top Executive from SBI
1moThanks for sharing. Enhanced risk management and better risk profiling of customers can help reduce defaults and stress in this essential part of financial sector. There is danger of a collateral damage. The NBFCs are under pressure to improve performance and profitability. This requires better recovery of loans. NBFCs are notoriously famous for deploying musclemen to recover their dues. Threatening and humiliating family members of the borrower has caused emotional distress. We need some industry level self imposed guidelines to avoid harassment of customers and their families.