The RBI's Crackdown: Protecting The Aam Aadmi Or Stifling Innovation?

A question and answer from an interview done in the past has stayed with me for life. I once asked the then Reserve Bank of India governor Yaga Venugopal Reddy who he visualised while formulating central bank policy. He responded promptly, "the aam aadmi”, the common man, the average person, whatever you want to call it.

There is a persistent disconnect between what the regulators think and what mostly newer entrants in the banking or financial services space think they are there for. The reactions to the recent crackdown on non-banking finance companies make it seem like the RBI governor should be more concerned about some venture capital firm in California dreaming up the next Apple Pay for India than anything else. Though these are the same firms who may have either just succeeded or failed spectacularly trying to do the same thing in China.

Or perhaps the RBI should prioritise the entrepreneur in Bangalore who sold that same dream, enabling the company to comfortably secure Series B or C funding, or worse, offload the entire risky venture onto unsuspecting retail investors in an IPO, as some have evidently done.

This leads to the question: why is the RBI taking such action?

The primary reason is the sheer growth of personal loans in the country and mounting evidence that borrowers are using these loans for lifestyle expenses or to invest in various financial and non-financial instruments. The overall trend reveals a concerning pattern.

The rapid growth of personal loans is evident in various segments. Credit card dues, for instance, were the fastest-growing as of July, surging by 22% year-on-year to nearly Rs 2.8 lakh crore, now accounting for over 1% of total bank loans, the Times Of India reported in September. Within personal loans, loans against gold jewellery saw the most significant increase, rising by 39%.

Overall, personal loans now represent the largest share of non-food credit at 32.9%, surpassing even the services sector, which accounts for 27.4%. According to the RBI's sectoral data, total personal loans grew by 14.4%, reaching nearly Rs 55.3 lakh crore. This trend has understandably placed personal loans under the RBI's close scrutiny, prompting periodic warnings. But the NBFCs in question would have you believe they are being singled out.

The RBI's crackdown was met with predictable outcry from certain quarters within the financial sector, who reacted as if the RBI's surveillance department had suddenly discovered a problem and issued closure notices overnight. Some argued that the crackdown would sound the death knell for the industry and there would be poor people who would be deprived of loan products they desperately needed.

It's actually the contrary but that is a different discussion.

The Reserve Bank cited several reasons for its actions, including failures to adhere to the Fair Practices Code, improper income assessments, and a disregard for borrowers' repayment capacities, particularly within the microfinance sector.

I further quote the RBI: “Inspections revealed alarming practices, including evergreening of loans, questionable asset classification, and inadequate disclosures.” Outsourcing core financial services further compounded these problems.

It is also worth noting that the RBI issued similar warnings in June of this year, cautioning NBFCs and microfinance institutions against charging usurious interest rates. Remember, many of these NBFCs are essentially fronts for mainstream banks who take on the slick app-based selling and overselling to customers, in the guise of customer acquisition and growth of course.

The ease with which loans can be obtained through a simple smartphone swipe undoubtedly contributes to increased borrowing. It works just like TikTok which is considered to have the worst or best algorithms to keep you and your brain glued to the screen for the longest time possible. The difference here is, in addition to your brain matter, it's your savings that are getting drained out.

Beyond the immediate concerns about NBFC practices, there are broader issues at play. The RBI has been sounding the alarm about excessive small-ticket loans for over a year, particularly those used for stock market investing, including high-risk derivatives trading.

The governor's warning a few months ago underscores this concern: "Excess leverage through retail loans mostly for consumption purposes needs careful monitoring from a macro-prudential point of view. It calls for careful assessment and calibration of underwriting standards as well as post sanction monitoring of such loans."

Despite these clear warnings, many NBFCs have continued their aggressive lending practices, prioritising rapid growth over responsible lending. This issue extends beyond just the financial realm, impacting India's youth who are increasingly entangled in these debt cycles, transforming it into a social concern as well. Addressing a purely business-related problem would be comparatively simpler.

Undeniably, the past four years have witnessed unchecked growth in consumer lending, arguably fueled by overall economic growth. However, India is also experiencing levels of borrowing and market speculation that seem disproportionate to other economic indicators. Regulators have to be alert and they will be hauled over the coals if it were to emerge that they were sleeping on the wheel.

However, regulators face limitations when companies entering this space operate with a fundamental misunderstanding of their role within the larger financial ecosystem.

India's banking and financial services sector holds immense potential. Addressing this market in a commercially relevant and responsible manner is crucial for both economic growth and social progress. This requires a deep understanding of the Indian consumer, particularly in the context of lending practices.

Y V Reddy's focus on the "aam aadmi" underscores the importance of considering the average person's needs and vulnerabilities while formulating financial strategies. This principle is not merely an academic exercise but a vital consideration for building a sustainable and inclusive financial sector in India.