Why does Sukhi Lal still exist in India? The character of the evil moneylender from the old Indian film Mother India released in 1957 is relevant today because the practice of usurious moneylending still exists. They say that the vicious cycle of monthly compound interest is so powerful that it will always haunt the customer, even after his death.
A large number of people are trapped in the informal credit system, where they have to pay exorbitant interest rates to illegal moneylenders for even small amounts. But with the proliferation of technology and the emergence of FinTechs, there is a shift, with even formal lenders targeting borrowers at the bottom of the pyramid. This has led to a huge increase in the exposure of many large banks and NBFCs to unsecured credit segments. While this is happening, the Reserve Bank of India, sensing systemic risks, this month increased risk weights to 125% from 100% for credit exposure to unsecured consumer loan categories. This move aims to reduce the growth of unsecured lending and force lenders to review their strategies.
The race of credit
My friend who wanted to buy a washing machine told me that the seller was very keen to sell it to him on EMI. Even when he didn’t want it on credit, the salesperson continued to explain how beneficial it is to buy a product on credit rather than debit. In fact, the credit for consumer durables is also available without any interest. The competition for offering credit is so high that every consumer durable shop, from supermarkets and shopping centers to even a small shop, has a loan agent stationed. Credit is available for everything from buying any product on e-commerce sites to borrowing just for a week under the personal loan category, starting from just Rs 2,000.
With the seamless availability and greater marketing of loans, consumers are also tempted. While there are need-based borrowers, many borrow because it is readily available. Covert finance is quite an important business for electronic companies and lenders. According to McKinsey data, retail credit grew much larger than corporate, SME and agricultural segments. The share of retail in total credit was 25% in FY18, which reached 32% in FY23. Of the total retail segment, credit card contribution is 7.1%, personal loan is 5.8%, and consumer durables is 4.1%.
Lenders went hammer and tongs to push their credit card and personal loan business.
In the world of unsecured loans
Generally, unsecured loans are unsecured. On the one hand it is a help for those underserved customers who are looking for credit. But on the other hand lenders charge them heavy interest rate compared to the other loan products. First, it seems to encourage that lenders bring in insufficient people in the formal credit segment. But the reality is different. Also, lenders charge them heavy interest rates, not as high as what Sukhi Lals charges, but they are also not as reasonable as the other retail loan products.
RBI’s view
In a recent speech, the RBI Governor Shaktikanta Das while referring to Microfinance Institutions, said, “Although the interest rates are deregulated, certain NBFC-MFIs seem to be enjoying relatively higher net interest margins. It is indeed for microfinance lenders to ensure that the flexibility given to them in setting interest rates is used judiciously. They are expected to ensure that interest rates are transparent and not usurious,” The use of the word ‘usurer’ is interesting here. (Usury means: practice of usury; charging illegal or excessive interest rates for the use of money)
This shows that RBI is not only concerned about the crimes it may face but also warns them not to become Sukhi Lal.
The believed reality
India is a credit starved country. According to McKinsey, India remains a credit underpenetrated market with 50% of the eligible population uncovered. There is greater scope for lenders to underwrite the customer more sensibly and bring hyper-personalization to avoid delinquencies. In fact, it should become the lender’s responsibility to spot the right borrowers, and they shouldn’t charge anyone and everyone just because they get the customer and can charge hefty interest rates. If the borrower turns out to be not-so-credible and defaults on payments, not only will his credit history be jeopardized for life, the lender will be responsible for bringing a bad customer into the system. In short, lenders should not become the digital avatar of Sukhi Lal by encouraging the customer to borrow, and then punish him with heavy recoveries and maligning his credit standing.
Currently, most of the customer acquisitions are done by FinTech companies according to the basic underwriting standards set by the lenders. But this can vary from customer to customer. Greater checks are also required when lending to new credit customers on need-based lending. With digital lending, lenders will bring people who need credit into the formal sector, but they can also attract high-risk customers.
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(The Editor’s View is a column written by Amol Dethe, Editor, ET BFSI. Click here to read more of his articles exploring several buzzing topics.)