India’s banking sector is bracing for a significant challenge, with a leading global credit rating agency predicting a 25 per cent increase in non-performing assets (NPAs) over the next two fiscal years. This alarming projection is attributed to rising stress in unsecured retail loans, particularly personal loans and credit card borrowings. While the banking system has shown resilience, the rapid growth in unsecured lending has exposed systemic vulnerabilities that require immediate attention. Over the past three years, unsecured retail loans have grown at a staggering pace, with personal loans and credit card borrowings expanding annually by 22 per cent and 25 per cent, respectively.

This growth, while reflective of robust consumer demand, has raised concerns about its sustainability. Unlike secured loans, which are backed by collateral, unsecured loans are entirely reliant on the borrower’s creditworthiness, making them highly susceptible to economic shocks such as job losses or inflation. Recognising these risks, the Reserve Bank of India (RBI) increased the risk weights for unsecured lending by 25 percentage points in November 2023. This regulatory move has contributed to a slowdown in loan growth, with personal loans and credit card borrowings expanding at a reduced rate of 11 per cent and 18 per cent, respectively, in the current fiscal year. However, while this measure addresses some immediate concerns, it may not fully mitigate medium-term risks. Private sector banks, which have aggressively expanded their retail lending portfolios, now face a balancing act. They must continue to grow their loan books to remain competitive while simultaneously implementing robust risk management strategies.

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Advanced data analytics, improved credit scoring models, and stricter underwriting practices will be critical in managing these risks effectively. Moreover, the increasing reliance on retail loans signals a shift in banking strategies, underscoring the need for innovative approaches to balance growth ambitions with long-term risk management. Despite these challenges, the credit rating agency has forecast a decline in the impaired-loan ratio, thanks to strong profitability and efficient operations within the banking sector. It expects the ratio to drop by 40 basis points in the current fiscal year and by another 20 basis points in FY 2025. However, this optimistic outlook should not overshadow the underlying risks highlighted by the predicted rise in NPAs. To ensure sustainable growth in retail lending, banks and policymakers must work in tandem.

Strengthening regulatory frameworks, promoting financial literacy among borrowers, and fostering a culture of responsible lending are essential steps to safeguard the sector’s longterm stability. The lessons from the rapid expansion of unsecured lending must serve as a wake-up call for the sector to adopt more prudent practices. India’s banking system stands at a crucial juncture. The choices made today will determine whether it emerges stronger and more resilient or succumbs to the pressures of unchecked risk-taking. With proactive measures, the sector can turn this challenge into an opportunity to build a more sustainable and secure financial ecosystem