The recovery phase from the global turmoil is under progress. Although still shaky, the financial firms are stabilizing. It started out with plummeting interest rates to promote consumption in the US market which prompted the housing prices to go up. Irrational lending and plethora of new complex financial product which were overlooked by the regulators created a bomb which exploded the moment the string was loosened and defaults started happening. India although was quite isolated from the US mortgage market, still had to face shaky impacts through the financial channel, real channel and the confidence channel. The Indian Banks had little exposure to the US market couple with the sound and conservative pillars on which they lie, were able to save themselves from any catastrophe. But they were also swept in the booming economy spirit and went into a reckless lending mode. There may be a possibility of a financial bubble bursting in the Indian Retail Lending market if enough care is not taken. It is only prudent for Indian Banks to take a wise look at the recent crisis and incorporate the lessons for survival in the future.

Retail Lending in India basically consists of Mortgage/Home Equity Loans, Vehicle Loans, Loans against shares, Personal Loans & Credit Cards, with Mortgage Loans being the least risky as its secured by assets and Credit Cards being the most risky.

Retail Banking

Traditionally banks have been lending to individuals based on their purchasing power, requirement and demographics. Retail banking was not very popular earlier and only caught speed in the mid 90s when due to liberalization, the purchasing power of consumers and standard of living started increasing. Since then it has been a fast growing market. Retail credit constitutes about 25% of the total credit and has grown by 28.0% to INR4,218.3 billion. During 2006-07, gross credit extended by Indian commercial banks grew by 34.83% to touch INR19,495 billion. Till 2010, retail banking is expected to grow at a CAGR of 28% to touch a figure of INR9,700 billion. It’s a sector which is going to be a profitable segment for the banks always. This charm coupled with the booming economy provoked banks to venture aggressively in it. Numerous loan schemes came out in India and it was pretty easy to get loans during 2007-08. This can be verified by the numerous calls from banks about loan and credit card offers that were on the rounds. Since income levels were rising banks perceived low risk in lending and often shifted towards reckless lending.

Now that a slowdown in there, bonuses and salary increments are on a decline, banks are fearing of defaults on the huge pile of loans that they have given out. Non-performing assets(NPA) for banks have increased from 2% to 4% and it is a cause for worry. The biggest worry is from the credit cards market. In a drive to provide each consumer with multiple credit cards, banks have ended up with a wide spread of low frequency card users. This is turning out to be non-profitable since the transactions costs involved are high. Moreover, the probability of defaults and frauds in credit card payments have been rising. Industry estimates showed that the default has increased by 50-70% over last year. Given the high interest rates that are being charged for credit cards, the risks of defaults are obviously higher.

Credit Cards scenario is just an example to show that despite the isolation of Indian Banks, the risks are there and lessons from the sub-prime crisis to avoid one in India. The first lesson is that multiple borrowings should be regulated and appropriate credit analysis needs to be done before lending in such cases. Banks should also opt out of high growth trajectories driven by debt-financed consumption and housing spending. Specifically for Indian scenario, Indian Public banks which have majority market share and can be easily regulated should be strengthened,so that during times of crisis the situation can be well managed through these banks. The strengthening should be in terms of a stronger top management and efficient risk profile. Banks and regulators have to ensure that frauds in housing loans and credit cards are strictly dealt with and reckless lending is avoided. Moreover, SPV and innovative financial products designed by banks and financial institutions should be reviewed for risk factors and released only after moderation. These products although heavily profitable during good times can act as disaster triggers during weak times as was seen in the recent global turmoil. More specifically from the banking side, banks need to ensure greater transparency and accountability in their operations. Customers need to be educated about all the hidden costs and such hidden costs should be included when evaluating the credit capability of the customer. Customers should also be advised on their financial needs and strengths so that a healthy relationship can be maintained from both sides.

Banks need to devise strategies and look at retail lending in the future from a structured and balanced viewpoint. Banks have to now focus on Strategic Retail Lending. This implied having well defined allocations for different segment of lending so that risk limits specified for each sector can be adhered to. Upper limits needs to be defined and strictly followed in accordance with the retail portfolio that the bank intends to have in accordance with its risk appetite. Banks could also look at implementing a Credit Appraisal System where a credit rating is given to individuals and it can be consistent across all banks. CIBIL can play a major role here with it already having started the process of forming a database of the credit history of individuals. These credit scores can also be used by banks to look at the possibility of risk based pricing where interest rates are charged based on the risk profile of the customer. This will also be beneficial for an individual with excellent credit history who can then negotiate for a lower interest rate. In the rural segment, where probability of defaults are high given high dependence on monsoons, the banks can act as facilitators. Given the increasing need for financial inclusion, apart from giving loans, banks can provide value based services like tie ups with farming equipment manufacturers and encouraging non-agricultural sources of income. This would not only ensure a better living standard for farmers but also ensure a constant source of cash flow for banks that have lent out, reducing default probabilities.

The future outlook for the Indian Retail Banking Industry looks good. Given the huge untapped market of semi-urban and rural areas, the opportunities are huge. The future will see Banks with well defined systems and procedures emerge as leaders. Learning lessons from every event at every step and moving with a well developed strategy would certainly be the key to success.

The article expresses personal views of the blog author. Comments are appreciated.

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