Contents
1. RETAIL LENDING UNTIL NOW 3
2. EVOLVING PRACTICES 11
3. DIFFICULT TIMES 19
4. FINE TUNING THE RETAIL LENDING MODEL 22
5. CONCUSION 25
Finsight Media
104, Hillside-1, S. No. 1, Baner Road, Pune 411045, INDIA. Tel: +91 20 40788537 Fax: +91 20 40789451 eMail: [email protected]
Copyright 2009: Finsight Media. All Right Reserved
Research Sponsors:
Retail Lending
Balancing Concerns in Difficult Times
Author:
Hari Misra
Editor-in-Chief
Finsight Media
A pioneering initiative from Arcil
3
IBA - Finsight Special Report
February 2009
Research Sponsors:
1. RETAIL LENDING UNTIL NOW
1.1 Defining retail loans
The term 'retail lending' has different connotations in different contexts. For
instance, Basel Committee on Banking Supervision (BCBS) defines retail exposures
which fulfill the four criteria of orientation, product, granularity and low value of
individual exposures, as laid down in its document titled 'International Convergence
of Capital Measurement and Capital Standards: A Revised Framework'. The RBI
Report on Currency and Finance provides a working definition: 'Retail or household
credit comprises mainly of housing loans, advances to individuals against fixed
deposits, credit card, educational loans and loans for purchase of consumer
durables'. For the purpose of this report, we shall use this definition of retail loans.
1.2 Pattern of growth
Retail lending by banks in India gathered momentum following financial sector
reforms in 1990s. Till then, most of the banking credit was focused on agriculture,
industry, and commerce. The major role of bank lending till then was to support
supply. To ensure that bank lending does not go to finance consumption, the
regulator had put various restrictions on retail credit such as limits on total amount
of housing loan and loans to individuals. Banks could lend only a specified small
percentage of their total lending to individuals for non-productive purposes. The
regulator also imposed strict norms for rate of interest, margin stipulation and
maximum repayment period. These restrictions were gradually relaxed during
1990s which paved the way for increased retail lending by Indian banks.
During the period from 1992-93 to 2005-06, retail loans grew at an average annual
growth rate of 28.4 percent against 19.5 percent growth of overall bank credit
during this period. The annual growth rate of retail loans was greater than the
overall credit growth throughout this period, except in FY 1998-99. It would be
recalled that the year 1997 witnessed the South East Asian Currency Crisis. However,
the annual growth rate of retail loans dipped below the overall credit growth in the
last two financial years, viz 2006-07 and 2007-08. Even in the current financial year
retail loans growth rate is expected to lag behind the overall credit growth rate.
Consequently, the share of retail loans in total bank credit increased from 8.3
percent at end-March 1993 to 22.3 percent at end-March 2007. Chart 1 depicts the
annual growth rates of retail loans and total bank credit during this period on the
left axis as line graphs, and the percentage share of retail loans in the total bank
credit on the right axis as bar graphs.
It is also interesting to look at the share of retail loans in total bank credit in various
bank groups-foreign, private, nationalised and State Bank of India (SBI) group. Chart
2 presents the comparison at three points of time-1996, 2000, and 2007.
The share of housing loans in total bank credit was a dismal 3.2 percent in 1998-
99. But in 2006-07 housing loans constituted 11.8 percent of total bank credit. The
share of housing loans in retail credit first declined from 37.3 percent at end-March
1993 to 27.7 percent by end-March 1998, and then rose sharply to 52.8 percent at
Retail Lending: Balancing Concerns in Difficult Times
end-March 2007. Table 1 depicts the relative growth rates of housing loans and
total bank credit, and the percentage share of housing loans in retail loans during
1993-2007.
4
IBA - Finsight Special Report
February 2009
Research Sponsors:
Source: RBI
Chart 1. Trends in Retail Loans Growth
Chart 2. Share of Retail Loans in Total Bank Credit- Bank Group-wise
(End-March)
Source: RBI
Retail Lending: Balancing Concerns in Difficult Times
5
IBA - Finsight Special Report
February 2009
Research Sponsors:
In her keynote address in a conference on 'Retail Banking Directions: Opportunities
& Challenges' in 2005, Shyamala Gopinath, deputy governor, Reserve Bank of India
(RBI), had listed the following four major drivers responsible for the boom in retail
credit market at that time:
1.3 Drivers of growth
1.3.1 Point of view of regulator and bankers
1. Economic prosperity and the consequent increase in purchasing power
2. Changing consumer demographics
3. Technology
4. Declining interest rates
Let us look at each of these drivers in a little more detail.
1. Economic prosperity and the consequent increase in purchasing power
'During the ten years after 1992, India's economy grew at an average rate of 6.8
percent and continues to grow at almost the same rate,' Shyamala Gopinath had
observed in her abovementioned keynote address in 2005. This has given a fillip to
a consumer boom, she had emphasised. This high economic growth resulted in
Table 1. Growth of Housing Loans
Retail Lending: Balancing Concerns in Difficult Times
6
increased job opportunities in urban areas. The reforms had liberalised the
economy paving way for attracting sizeable foreign investment. Job opportunities in
IT and IT-related activities expanded and income levels rose sharply.
In addition to the metros, demand for housing was fuelled by the emergence of a
number of second tier cities as upcoming business centres. Tax incentives for
interest paid and principal repayments towards housing loans brought down the
effective rate of interest.
2. Changing consumer demographics
India has a vast potential for growth in consumption both qualitatively and
quantitatively. It is one of the countries having highest proportion (70 percent) of
the population below 35 years of age. Increasing literacy levels and adaptability to
technology are the two other factors which have helped retail lending to grow.
Another key factor is the emergence of affluent middleclass, which is expected to
grow in numbers further. The present generation of young and affluent working
population in India has shed the paradigm of 'save now, consume later' of the
earlier generations to 'affordable indulgence'.
3. Technology
Technology has played a major role in the growth of retail banking. It has reduced
the cost of transaction, which is a critical factor in dealing with low ticket size of
retail banking. Alternate delivery channels in the form of plastic cards (both credit
and debit), ATMs, Internet and phone banking, and anywhere banking supported by
centralised core banking solution have transformed retail banking experience and
attracted new customers. Technology has also helped in managing the customer
lifecycle, automating and centralising credit origination process, and credit risk
management in retail lending.
4. Declining interest rates
One of the major achievements of controlled pace of economic reforms in India was
managing growth without undue rise in inflation. The inflow of foreign investments,
both direct and indirect, had created ample liquidity. The inflation risk premium
came down resulting in a decline in both nominal and real interest rates, which in
turn, had a positive impact on the demand for retail loans.
1.3.2 Other drivers
Growing disintermediation
Financial sector reforms in the 1990s also created more avenues for corporates to
raise funds. Greater transparency and relaxed controls resulted in deepening and
broadening of domestic equity and bond markets, allowing corporates to raise
funds from these markets at a lower cost.
Big companies were also allowed to raise funds from external markets. As a result,
IBA - Finsight Special Report
February 2009
Research Sponsors:
Retail Lending: Balancing Concerns in Difficult Times
7
the demand for bank credit by the industrial sector slowed down, especially
between 1996-97 and 2001-02, which forced banks to look for alternate avenues of
lending.
Credit risk diversification
At the beginning of the reforms process, banks were burdened with a high
percentage of non-performing assets (NPA) in their commercial and industrial
lending portfolio. Banks looked at retail loans from the point of view of
diversification of their loan portfolio, because in retail loans, the average ticket size
is small and loans are widely distributed over a large number of borrowers. So, the
average risk associated with retail loans is lower than corporate loans. In fact, risk
adjusted return on retail loans is significantly higher than the corporate loans
during normal times.
Information asymmetry
This is perhaps the least talked about driver of retail lending. In retail lending (in
fact, in the entire gamut of retail banking), there is an inherent inequality between
the bank (which is a large organisation), and the customer (who is an individual).
This inequality emerges from information asymmetry, legal resources, and the
capacity to negotiate and withstand losses.
One of the major manifestations of information asymmetry in retail lending is the
standard form contracts and fine print, which hardly any retail customer ever reads
or understands fully. Standard form contracts are not a result of a negotiation
process; they are offered on a take-it-or-leave-it basis; and contain various clauses
in fine print (or in lengthy documents) which mostly operate to the disadvantage of
the customer.
The feedback received in this aspect even from those retail customers who are well-
educated and brilliant professionals; comes as a surprise. Most of them are not able
to fully understand the mechanisms of floating and fixed rates of interest in
housing loans, as specified in the loan documents. For less educated the
mechanism of Equated Monthly Instalments (EMI) serves well to hide the effective
interest rate. Many retail customers do not possess the financial literacy to
differentiate between various products offered by different banks.
Unequal resources
Retail loan customers, being individuals, do not have the same level of resources as
banks possess by virtue of being large organisations. Any action of the bank
ranging from levying of hidden charges, sending unsolicited credit cards, wrong
credit reporting, unlawful activities of recovery agents, and not performing their
side of the contract, cannot be effectively handled by the individual customer,
because he cannot afford to invest time and money required to counter most of
such actions.
The RBI has initiated measures to support retail loan customers, which are detailed
later in this report.
IBA - Finsight Special Report
February 2009
Research Sponsors:
Retail Lending: Balancing Concerns in Difficult Times
8
1.4 Analysis of retail credit growth
Retail loans can be classified based on three main parameters. One obvious
classification is whether the loans are secured or unsecured. In this classification,
housing, auto loans, loan against fixed deposits or any other financial security form
one category, while credit cards, personal loans, and most educational loans fall in
the other category. Another relevant parameter on which retail loans can be
classified is the tenure of the loan. The tenure ranges from 45 days in the case of
a credit card (when there is no roll-over) to over 10 years for housing loans. And
lastly, such loans can be classified on the basis of the social desirability. Housing
loans and education loans for overseas education up to INR 20 lacs (for domestic
education up to INR 10 lacs only) are considered to be priority sector loans.
1.4.1 Housing loans
It comes as no surprise that housing loans constitute roughly half of the
outstanding retail credit in India. These loans are secured by mortgage of
residential property which is quite easy to sell in the market. Up to INR 20 lacs such
loans qualify as priority sector advances, and borrowers who live in these houses
(self-occupied) are interested in retaining ownership, so default rates will be under
control under normal circumstances. For quite a long period the prices of
residential houses kept rising, so there was also no issue of deterioration in value
of the security over time. There has been a prevailing practice of undervaluing the
property for evasion of taxes and stamp duty, under which part of the actual price
paid for the property was paid in cash. The practice was undoubtedly unlawful, and
has been controlled by various administrative steps by the government. But, from
the bankers' point of view it provided another disincentive against default (it has the
effect of increasing effective margin).
Rate of growth of housing loans has been consistently above the overall growth rate
of bank credit since 1997-98 till 2005-06, during which period the share of housing
loans in retail loans also increased from 27.7 percent to 51.6 percent. During this
period, there have been years when the housing loans grew at a rate of 45 percent
and above (the highest growth rate was 73.9 percent in 2003-04). Three factors had
a combined impact on the growth rate of housing loans during this period. These
factors were actual and anticipated movement in prices of houses, effective interest
rates, and the risk weights prescribed by the RBI.
For instance, the risk weights on housing loans extended by banks to individuals
against mortgage of housing properties and investments in mortgage backed
securities (MBS) of housing finance companies, recognised and supervised by
National Housing Bank (NHB) were reduced to 50 percent in May 2002 for capital
adequacy purposes, with a view to improving the flow of credit to the housing
sector. The growth rate of housing loans immediately shot up to 49.5 percent in FY
2002-03 from 29.2 percent in 2001-02. It further increased to 73.9 percent in FY
2003-04. The spurt in housing loans and other retail loans during these two years,
which was also due to decline in interest rates which had come down to as low as
7-7.5 percent for housing and four wheelers, forced the regulator to increase the
risk weight on housing loans to 75 percent and on other retail loans from 100
percent to 125 percent in October 2004.
IBA - Finsight Special Report
February 2009
Research Sponsors:
Retail Lending: Balancing Concerns in Difficult Times
9
During the years of exceptional growth of housing loans, competition intensified,
which in turn, adversely impacted the quality of credit origination. As we shall see
later in this report, this has started reflecting in the rising delinquencies in retail
loans.
1.4.2 Credit cards
Foreign banks in India were the first to start the retail lending revolution in India.
To overcome the restriction imposed by the branch licensing policy of RBI, these
banks began targeting retail customers through other delivery channels. Credit card
was the first product that foreign banks offered to retail customers in India. These
banks operated through franchisees for selling cards, collections, and acting as
customer contact points. Payments of card bills could also be made at courier
service providers' offices, and at own ATMs through cheque drop box mechanism.
Cards were issued for an annual fee, but the major source of revenue was the
commission charged to merchants. It is outside the scope of this report to go into
the operational details of credit card product. To increase revenues from
cardholders, card issuing banks started the practice of part payment of bills (with a
mandatory minimum amount which came down to as low as 5 percent of the
monthly bill amount), allowing cash advances at ATMs (some public sector banks
did it at their branches), and by offering dial-a-draft facility for certain utility bills.
Rolled over bill amounts attracted an astronomical rate of interest (2.5 percent to
3.5 percent per month), which has remained by and large uniform among banks and
across time and has no correlation with prevailing interest rates for other products.
While the credit cards were introduced in the country more than 20 years ago, their
growth in the first six years in this century has been phenomenal. Starting with a
base of 3.7 million in 2000, the number of credit cards issued has grown to 27
million at present. The credit card subscriber base grew at a rate between 25 and
35 percent annually till FY 2006-07. The rapid growth in the subscriber base can be
attributed to the aggressive issuance of credit cards by top 5 players in the industry,
viz ICICI Bank, Citibank, SBI, HDFC, and Standard Chartered. Though a late starter,
ICICI Bank has surpassed the established foreign banks like Citibank and Standard
Chartered by a wide margin. ICICI Bank's credit card subscriber base is around 9
million which accounts for over 30 percent share of the market. A similar growth in
deployment of point-of-sale (POS) terminals at merchant sites also took place during
these six years taking the number of POS to over 3,00,000 about ten times the
number in 2001. ICICI Bank tops the charts here too, with over 1,00,000 POS
terminals followed by HDFC Bank. In a sharp contrast, SBI has chosen to be just the
issuer but not the acquirer-it has not deployed POS terminals. Citibank and Standard
Chartered also have not shown any interest in acquiring transactions by installing
POS terminals. Despite these impressive numbers of growth, the transaction
amount per card has not increased much, as is evident from Table 2, which shows
the data for three years.
1.4.3 Education Loans
Due to the gradual reduction in government subsidies, and proliferation of private
educational institutions for professional courses, higher education has become
IBA - Finsight Special Report
February 2009
Research Sponsors:
Retail Lending: Balancing Concerns in Difficult Times
10
quite costly. Education loans provide financial assistance to deserving students to
enable them to pursue higher education. These loans play a great role in
development of human capital of the country. The real push for educational loans
came from the government in June 2000, when the finance minister underlined the
need for commercial banks to assist poor, but meritorious students for taking up
professional courses. A Study Group under the chairmanship of R J Kamath, then
chairman and managing director of Canara Bank was formed by IBA, to examine the
issue and suggest a model scheme of education loans to be adopted by all
commercial banks. The scheme was formulated by IBA and approved by
Government of India with some modifications. The scheme was advised to banks for
implementation by RBI in 2001. Under the scheme banks were not to insist on any
security for education loans up to INR 4 lacs. In 2004, a further relaxation was made
under which banks were to insist only for third party guarantee for loans up 7.5
lacs, and could ask for a tangible asset as a security only for loans above this
threshold limit.
To make the scheme attractive for banks, these loans were allowed to be classified
as priority sector loans upto limits as detailed earlier in this report. As a result of
these measures, the growth rate of education loans surged to 49 percent in FY
2005-06 before moderating to 25 percent FY 2006-07. State Bank of India has
emerged as the topmost lender in this category accounting for almost 25 percent
of the market share.
Bankers give a mixed feedback on default rates on education loans. Some banks
claim a negligible default rate while others say that tracking students after passing
out is a major risk. To give a further push to education loans, RBI advised banks
that 'under the Basel II framework, educational loans, no longer being a part of
consumer credit, would be treated as a component of the regulatory retail portfolio
and attract a risk weight of 75 per cent, as against 125 per cent at present' in
January 2008. The default rates in education loans are expected to rise as the job
market becomes difficult in the downturn.
IBA - Finsight Special Report
February 2009
Research Sponsors:
Table 2. Credit card usage
Retail Lending: Balancing Concerns in Difficult Times
11
2. EVOLVING PRACTICES
2.1 The basic model
As already mentioned, foreign banks were the first to start the retail lending in
India. They tried to create origination, collection, and recovery models which were
cost-effective, technology-intensive, and which allowed them to overcome their
weakness of having a limited branch network. They used franchisees or direct
selling agents (DSA) as they were later called, as the initial customer contact point.
These DSAs would sell the products, go to customer and get the application form
filled up, and collect necessary supporting documents. Lending process for retail
loans was centralised and also automated to a large degree using various
origination solutions and credit scoring models. Documentation was again got done
using the DSAs, while disbursements were made either by sending the cheque/draft
by courier. Call centres were set up for interacting with customers, and for
answering their queries and first order handling of grievances. For repayments,
cheque drop boxes were used for credit card bills, while EMIs for housing, personal,
auto, or consumer durable loans were taken via a mechanism of post-dated cheques
(PDC). Electronic Clearing Service (ECS) instructions were also taken in lieu of PDCs.
Follow-up was also outsourced, which was mostly done over phone, followed by
personal visits by recovery agents in case of defaults persisting despite phone calls.
Verification of KYC documents and income proofs were also outsourced.
In this model, the prospective borrower hardly interacted with any bank staff, and
there was no need for him to visit the bank branch, during the entire lifecycle of the
loan or credit card. DSAs were paid a small fee for each sanctioned loan or accepted
credit card application. The bank had to only create a good scoring model, which
would accept or reject the applications based on the data collected by DSAs and
verified by another outsourced agency. Since the selling expenses were borne by
DSAs, it was thought that they would take care and submit only good applications
to improve their profit margins.
When new generation private sector banks, went aggressively for retail loans, or
when SBI went aggressively after credit cards, they largely adopted the model
perfected by foreign banks. Public sector banks were not so aggressive (Chart 2
confirms it) in retail loans, and except for one or two banks these banks largely
followed a branch-centric retail loan approach using own staff for canvassing,
originating, and recovering retail loans.
2.2 How it evolved so far
'So far, the growth of retail credit in India has been largely an urban phenomenon,'
says Yogesh Agarwal, chairman and managing director, IDBI Bank. He is right on the
mark - despite healthy growth rates in retail credit since 1993; most of it was
concentrated in urban areas. How did the banks manage to get these impressive
growth numbers? In a presentation made in September 2004, when retail credit
boom was at its zenith, Chanda Kochhar, joint managing director, ICICI Bank, had
observed that retail credit was at 7-8 percent of GDP even at that time, and that
despite rapid growth in target segments there was still under-penetration of
finance. She had also pointed out that entry of banks in retail credit has led to
IBA - Finsight Special Report
February 2009
Research Sponsors:
Retail Lending: Balancing Concerns in Difficult Times
12
increased competition and coverage, aided by increasing use of technology to
enhance reach and accessibility.
Presenting the core model of retail credit then, Kochhar suggested that sales and
service need to be decentralised while transaction processing and credit monitoring
need to be centralised. This model would lead to economies of scale, and help
separate sales from credit policy and monitoring. The key focus in her presentation
was to look for benchmarks from other industries-manufacturing, retailing, and
hospitality to evolve a model for retail banking.
In practice, this model started showing cracks as growth and competition picked
up. Some of the prominent cracks are highlighted below:
Direct selling agents (DSA)
These were privately set up firms who employed less educated persons at a low
salary. From banks' point of view it was a cost-effective way to sell retail lending
products. Banks did not bother about the business model that these DSA firms had
adopted. Operating on a small fixed fee that they received from banks if their sales
were successful, DSAs and their ill-trained, lowly-paid sales people began indulging
in false promises about the products, finding ways to circumvent banks' credit
policies to increase their success rate, and intruding on the privacy of the customers
as they walked up to the branch or an ATM to transact some other business.
An irate customer of a large private bank had this comment to offer: 'Selling agents
were swarming outside and inside of the bank branch and its ATM centre, and
approaching customers in a manner which reminds one of touts at a railway
station'. 'The only difference is that touts at the railway station do not have
expressed permission of railways whereas these selling agents are acting on behalf
of the bank.'
Predictably, these low-paid sales people changed jobs quite frequently, and used
their contact lists (in some cases, even the photocopies of identity and address
proofs, photographs, and income proofs) in their new jobs with impunity.
Over time, these DSAs became the sole contact point for any prospective customer
for retail loans. Even an existing customer could not approach banks following this
model directly for a retail loan - bank staff had trained itself to deal with prospective
customers via DSAs only.
It is not possible to assess the extent of damage done to customer relationship and
bank reputation by irresponsible behaviour of DSAs, but the issue had caught the
attention of the regulator. Under its guidance, the Indian Banks' Association (IBA)
had formulated a model code of conduct for DSAs which could be adopted by banks
voluntarily.
The code addresses some of the issues which have been brought out, but leaves out
quite a few. But as we shall see later, this problem seems to have been resolved by
market forces.
IBA - Finsight Special Report
February 2009
Research Sponsors:
Retail Lending: Balancing Concerns in Difficult Times
13
Telemarketers from DSAs of different banks were repeatedly calling up the same set
of target customers. The problem of privacy invasion by such telemarketing calls
had reached such a proportion as to necessitate setting up of a no-call-registry.
While these DSAs played a significant role in the growth of retail credit, their
unregulated behaviour caused some structural damages. These were:
� Alienating good customers by intruding on their privacy
� Enticing good borrowers to over leverage
� Suppressing critical information to improve success rate of their sales
� Freely exchanging customer contact lists and private financial data
� Helping non-creditworthy borrowers to circumvent banks' credit policies
Multiple credit cards as debt trap mechanism
The very practice of allowing a credit customer to pay just 5 percent of the total
outstanding every month, which attracts a 3.5 percent monthly interest rate, seems
less of a convenience to the cardholder but more of a strategy to lock him up in a
debt trap. Quite a few credit card customers of an aggressive foreign bank have
expressed a view that their bank appeared to induce customers into a debt trap by
either increasing the card limit or offering another card to customers who were
rolling their card outstanding more or less regularly. In fact, the practice of sending
unsolicited cards, sometimes by the same bank to its existing customer, resulted in
multiple cards with a customer with the aggregate credit limits on all the cards that
he possessed quite high compared to his repayment capacity.
In December 2006, speaking on consumer and service issues in retail banking at
IBA-TFCI 2nd Retail Banking Conference, Kaza Sudhakar, chief general manager,
customer service department, RBI mentioned that his peon had been given cards by
six banks, with a credit limit of INR 25,000 per card. He was categorical in observing
that 'banks are interested in selling retail loans anyhow, even by resorting to false
selling and false promotions'. 'There is a lack of transparency; financially illiterate
customer is unable to make an intelligent choice from the slew of complicated
products being offered by banks,' he had observed.
While the issue of multiple credit cards by different banks to one customer could be
explained by the lack of effective data sharing between banks (we will come to this
when we discuss credit bureau), the practice of issuing multiple credit cards to the
same customer by the same bank defies logic. Why the credit limit on the existing
card could not be enhanced? Clearly, the unsuspecting cardholder was being
induced into drawing funds from one card to pay dues of another, and moving up
in the debt spiral. Competition between various card issuers had brought about a
practice of 'balance transfer' whereby one could transfer outstanding balances on
one bank's credit card to another bank's card. Such balance transfers usually
offered some discount on the rate of interest charged on balances so transferred
only for a limited period of time.
These practices lured cardholders to over leverage themselves. Multiple cards
issued to customers also explain very little growth in annual spends per card
despite phenomenal growth in the number of cards issued (See Table 2). Fierce
IBA - Finsight Special Report
February 2009
Research Sponsors:
Retail Lending: Balancing Concerns in Difficult Times
14
competition also resulted in the income criteria for the issue of new cards getting
reduced, which in turn prepared grounds for eventual defaults.
In addition to almost usurious rates of interest, credit card issuers levied many
charges, which were mostly in the nature of penalties. Some of these penalties were
skewed in favour of the issuers. For instance, the card issuing bank will quietly
authorise a transaction which would exceed the credit limit without making any
reference to the cardholder, but charge the penalty for exceeding the limit. Also the
penalty would be a flat amount which could be greater than the amount by which
the limit was exceeded. Similarly, late payment penalty would be levied for delayed
payments, but no card issuer accepted cash on due date, or gave receipt for
payment received by cheque. Credit card bill payment by cheque was forced to be
dropped in the box only.
Unsecured personal loans
Unsecured personal loans were another mechanism for ever greening of credit card
outstanding. These loans were, usually sanctioned to cardholders with a good
repayment history (includes those who could manage to rotate their outstanding
among multiple cards incurring heavy interest charges). This allowed the trapped
credit card borrowers some discount in interest rates (as compared to credit card
rates) though these rates too were quite high compared to other unsecured loans
like educational loans. Some of these loans were also used by borrowers for
holidays, social commitments, medical expenses etc.
Loans for auto vehicles and other consumer durables
In this category of retail loans, both competition and distributor/manufacturer
discounts kept the interest rates reasonable. Still, the mechanism of Equated
Monthly Instalments (EMI) and the practice of collecting advance EMIs (which some
banks borrowed from non-banking financial companies-NBFCs) did not make the
actual rate of interest transparent enough to be understood by most borrowers.
Stipulations of margin or down payment were reduced sometimes below the safety
percentage. (Some DSAs have reported that an aggressive private bank had
schemes for two wheelers where the down payment was as little as one rupee!)
From the socioeconomic point of view, these loans helped individual borrowers to
acquire necessary modes of transport and consumer durables which improved their
comfort and lifestyle. These loans also helped create the demand for white goods
in the economy, and thereby contributed to growth of the manufacturing sector. On
the flipside, auto loans increased the number of vehicles to such an extent in a
short period as to create traffic snarls and increase in pollution levels on account of
vehicle emissions.
Housing loans
In case of housing loans too, the rates of interest were beaten down to unrealistic
levels. But a software professional, who took a housing loan at a fixed rate of 7.5
percent from a private sector bank laments that there was too much in the fine
print, which was never explained to him at the time of sanctioning the loan. He is
IBA - Finsight Special Report
February 2009
Research Sponsors:
Retail Lending: Balancing Concerns in Difficult Times
15
liable to a much higher rate of interest because of various fine print clauses that the
bank never cared to explain in detail. He also feels that the terms of the reputed
builders and the banks are such that only the borrower suffers in the end. In his
case, the offer of a fixed rate of interest is a classic case of information asymmetry
and standard form contract. If an engineer trained in the topmost engineering
institute of the country fails to fully comprehend the exact nature of the loan
contract he is entering into, can one expect less educated borrowers to understand
what exactly they are contracting?
Rising interest rates have brought such fine print clauses into action, and the rising
EMIs are impacting the ability of the borrowers to pay.
From the banks' point of view, housing loans present a structural problem, because
of their long tenure. Banks can raise only short-term funds, and are exposed to a
greater interest rate and liquidity risk in long tenure loans. So, it is quite natural for
them to incorporate clauses that mitigate this risk. But why did the housing loan
interest rate come down as low as 6-7.5 percent? At this rate, the cost of funds,
transaction costs, and the risk costs cannot be met. Competition for market share
sometimes overshadows prudential business sense-aviation industry too has learnt
it the hard way.
Securitisation and sale
This approach provides an exit mechanism to the bank which had originated the
loan. During the period of high growth of retail loans, a few banks had perfected
this approach to bring down the rate of interest. This is the well-known 'originate
to distribute' model of retail credit, which has been the root cause of subprime
crisis. This model requires a vibrant secondary market for securitised debt. In India,
such a market is yet to reach maturity. Some banks bought housing loan portfolio
because it ranked for priority sector targets, while some bought auto loans portfolio
just to diversify without creating the origination infrastructure.
In early 2006, the RBI issued detailed guidelines on securitisation of standard
assets. Originating banks found the stipulations of capital adequacy and other
norms a bit stifling for the model that they had perfected. Also, the guidelines had
a retrospective applicability to securitisation deals entered into before the issue of
the guidelines. In hindsight, the guidelines did well to keep the 'originate to
distribute' model of retail banking under prudent checks. With unregulated
securitisation becoming a thing of the past, those banks, which were pursuing this
model in a big way, found themselves saddled with a large portfolio of retail
advances before they could put the brakes on the origination machinery. Such
banks now find themselves in both a liquidity crisis and a rising delinquency crisis.
2.3 Recovery approaches
The aggressive retail lending styles described above called for equally aggressive
recovery approaches. In addition to the usual follow up by phone and mail, three
main recovery approaches were employed by aggressive retail banks. These were:
� Post-dated cheques or ECS debit authority
IBA - Finsight Special Report
February 2009
Research Sponsors:
Retail Lending: Balancing Concerns in Difficult Times
16
� Use of Securitisation and Reconstruction of Financial Assets and Enforcement
of Security Interests (Sarfaesi) Act to sell properties
� Recovery agents
Post-dated cheques (PDC)
The basic idea behind taking PDCs is to use the threat of criminal prosecution in
case any of the cheque bounces. The mechanism of PDCs also creates a revenue
opportunity. The bank where the borrower has an account recovers charges for
issuing such a large number of cheques, and also levies penalties if any of the
cheque has to be returned unpaid. The bank which takes these PDCs also levies a
penalty if the cheque is returned unpaid.
Sarfaesi Act
This approach is available only for secured loans, and has been largely used for
housing loans. It has been found to be especially effective against those borrowers
who are living in the residential houses purchased out of loans.
Recovery agents
Aggressive retail lending banks outsourced the recovery and follow up activity also.
Initially used for recovery of credit card dues, the practice was expanded to cover
unsecured personal loans and auto loans later on.
Beginning with a polite reminding phone call that an EMI or card payment was
overdue, the outsourced agencies followed it up with more calls and sending agents
to collect the dues from the doorsteps of the borrower. These agencies were also
entrusted with the job of taking possession of hypothecated assets in case of
persistent defaults by the borrower.
There were some aberrations in this approach of outsourcing the recovery activity
to agencies where defaulters were subjected to intimidation, threats, and in rare
cases, use of brute force. Lack of background checks on their employees by the
outsource service providers, and proper training has been the main cause of such
rare incidents. Courts have imposed exemplary fines on banks holding them
responsible for the acts of their recovery agents resulting in criminal intimidation
of defaulters.
Using the services of recovery agencies is an established international practice in
retail lending. However, in most countries, there is a legally enforceable code of
conduct that these recovery agents have to follow.
2.4 Remedial steps by RBI and IBA
In 1974, IBA had come out with GRACE (Ground Rules and Code of Ethics) for banks
in their dealings with individual customers, says K Unnikrishnan, deputy chief
executive of IBA. These rules kept undergoing revisions till the banking reforms of
1990s, when the liberalisation rendered most of them irrelevant. In their place,
banks came out with citizen charters. In 2000-01, IBA had formulated a model
IBA - Finsight Special Report
February 2009
Research Sponsors:
Retail Lending: Balancing Concerns in Difficult Times
17
citizen charter. In June 2004, IBA came out with 'Fair Practices Code for Banking'.
Unnikrishnan recalls that a review of this code was undertaken by RBI and IBA, which
eventually culminated in 'Code of Bank's Commitment to Customers'.
BCSBI
In accordance with the recommendations of Tarapore Committee, Banking Codes
and Standards Board of India (BCSBI) was set up in February 2006. It was intended
to act as 'an independent and autonomous watchdog to monitor and ensure
that the banking codes and standards adopted by the banks are adhered to in
the true spirit while delivering their services' to retail customers. A twelve-
member working group was constituted by IBA, at the behest of RBI to draft the
'Code of Bank's Commitment to Customers', which was released in July 2006.
The code has been modelled on the lines of similar codes in UK, Canada, Hong
Kong, Singapore and Australia, and addresses the concerns of banks and retail
customers.
While the code does address some of the customer problems detailed above, such
as invasion of privacy, indecent behaviour of collection agents, and the lack of
transparency in disclosing various charges, fees, penalties and mode of charging
interest; it does not cover all.
National do not call (NDNC) registry
The privacy invasion by telemarketers of DSAs and call centres of banks has been
curbed by establishment of NDNC registry by the Telecom Regulatory Authority of
India. The practice is yet to stop completely, but the improvement is visible.
RBI guidelines on credit card operations of banks
In its updated master circular dated July 2, 2007, the RBI sought to regulate the
credit card operations of banks. At the outset, the RBI observes that 'credit card
portfolios of banks mirror the economic environment in which they operate'. 'Very
often, there is a strong correlation between an economic downturn and
deterioration in the quality of such portfolios. The deterioration may become even
more serious if banks have relaxed their credit underwriting criteria and risk
management standards as a result of intense competition in the market.'
These guidelines comprehensively address the issues outlined above in respect of
credit cards and recovery agents. The guidelines prohibit issue of unsolicited cards,
defines what constitutes most important terms and conditions (MITC) which need
to be highlighted, advertised, and sent separately to the prospective customers at
all the stages - marketing, at the time of application, at the acceptance stage, and
in important subsequent communications. Detailed instructions with respect to
wrong billing, debt collection practices, code of conduct of DSAs and recovery
agents, reporting to credit bureau as a defaulter, dispute resolution etc constitute
these guidelines which state that 'the card issuing bank/NBFC would be responsible
as the principal for all acts of omission or commission of their agents (DSAs and
recovery agents).
IBA - Finsight Special Report
February 2009
Research Sponsors:
Retail Lending: Balancing Concerns in Difficult Times
18
RBI guidelines on recovery agents
The din and furore caused by grossly illegal and criminal activities of the recovery
agents employed by some banks (mostly private and foreign) in the media, and very
strict view taken by the courts, forced RBI to issue guidelines to regulate this
practice. In the mid-term review of the Annual Policy for the year 2007-08, the
regulator had noted that 'in view of the rise in the number of disputes and
litigations against banks for engaging recovery agents in the recent past, it is felt
that the adverse publicity would result in serious reputational risk for the banking
sector as a whole. A need has arisen, therefore, to review the policy, practice, and
procedure involved in the engagement of recovery agents by banks in India.' The
first draft of the guidelines was issued in November 2007, and the second draft
which incorporated the feedback of various stakeholders was issued in March 2008.
Under these guidelines, banks have been asked to have a due diligence process in
place for engagement of recovery agents, which would include 'verification of the
antecedents of their employees, through police verification, as a matter of abundant
caution'. Banks have been instructed to inform the borrower about the details of
recovery agents while forwarding default cases to the recovery agents, who should
carry the authorisation letter from the bank along with their identity card.
Conversation of recovery agents with the borrower will have to be recorded. The
methods followed by these recovery agents will have to follow the guidelines issued
by RBI on outsourcing of financial services in November 2006, guidelines on fair
practices code for lenders issued in May 2003, guidelines on credit card operations
as mentioned earlier, and the relevant provisions under BCSBI code pertaining to
collection of dues.
One of the major provisions of these guidelines was to train the recovery agents and
issue them a certification. IBA has tied up with Indian Institute of Banking & Finance
(IIBF) for offering such a course. It is estimated that there are roughly 1,35,000
recovery agents in the country at present. It has been therefore decided that the
banks will be allowed to use the services of uncertified recovery agents till April
2009, after which date only certified recovery agents can be engaged by banks.
Other provisions relate to redressing customer grievances, not inducing these
agents through very stiff targets or high incentives to resort to illegal activities,
increasing use of Lok Adalats for recovery of loans below 10 lacs, and use of credit
counsellors for sympathetic consideration of genuine difficulties of borrowers.
IBA - Finsight Special Report
February 2009
Research Sponsors:
Retail Lending: Balancing Concerns in Difficult Times
19
3. DIFFICULT TIMES
3.1 Growth of retail credit slows down
In FY 2006-07 the growth rate of retail loans dipped below the overall credit growth
rate and has remained below it till now. Though the retail credit growth peaked in
FY 2003-04 to above 50 percent, it was still above 30 percent in FY 2004-05 and
2005-06. Housing loans growth rate moderated to 25.7 percent in FY 2006-07 and
to 12 percent in 2007-08, according to RBI's report 'Macroeconomic and Monetary
Developments 2007-08'. But Housing Development Finance Corporation (HDFC)
reported growth rate in housing finance at 26 percent during these two years,
whereas LIC Housing Finance saw a 41 percent increase in sanctioned loans and a
38 percent rise in disbursed loans in 2007-08.
In FY 2007-08, growth in new credit card accounts was 18 percent, against 33
percent in the previous year. But the growth in credit card receivables has been 86.3
percent between August 2007 and August 2008, which was 49.5 percent between
August 06 and August 07. It is alarming. In fact the exposure of banks to high-risk
unsecured customers, through personal loans and credit card receivables had gone
up from 6 percent in 2004 to 17 percent of total outstanding retail loans in March
2007, according to Credit Rating Information Services of India Limited (CRISIL).
Consumer durable loans rose between August 06 and August 07 at the rate of mere
6.3 percent, and have registered a decline of 7.9 percent in the next year.
Clearly, the mix of retail loan outstanding has shifted towards more unsecured
loans.
3.2 Reasons for slowdown
Rising interest rates
Main cause of the reduction in growth rate of retail credit has been the decrease in
the growth rate of housing loans, which accounts for over 50 percent of total retail
loans. Most bankers attribute the slowdown in housing loans growth to rising
interest rates on one hand and rising property rates on the other. Rise in interest
rates also impacted auto loans to some extent.
Increasing delinquencies
'One who lives by the sword, dies by the sword,' goes the maxim. The retail lending
revolution was led by foreign banks till 2001, but the new generation private sector
banks took the baton from them thereafter (see Chart 2). Some of the private sector
banks had over 65 percent of their total loans portfolio as retail loans. These banks
had to apply brakes in the wake of rising defaults, which in turn, brought down the
retail credit growth of the banking industry.
Fierce competition for market share in retail credit has resulted in asset quality
impairment and over leveraging of retail customers up to 20 times their annual
income during the periods of high growth. This is now manifesting itself as
IBA - Finsight Special Report
February 2009
Research Sponsors:
Retail Lending: Balancing Concerns in Difficult Times
20
increased non-performing loans in retail segment. Many of the retail customers
were first-time borrowers from the organised market, and had no credit history.
The 86.3 percent rise in credit card receivables is a sure sign that delinquencies will
appear in this retail credit sooner or later. A private bank, on conditions of
anonymity, attributes this rise in credit card receivables to the restrictions placed
on recovery agents by the RBI, and recent court judgments.
A report by CRISIL estimates that the proportion of gross NPAs to retail advances
will rise to 4 percent in March 2009, from 2.7 percent in March 2007. A leading
private sector bank has seen a 78 percent increase in the level of its gross NPAs in
its retail loan portfolio in March 2008.
However, Dr K Ramakrishnan, chief executive of IBA says, 'I do not expect defaults
on account of the EMIs going up as a result of interest rate hikes'. The EMIs are
going to go up. 'If there is a genuine problem for a customer because of the bank
increasing the interest rates from time to time which is adding to the increased EMI,
there are instructions in place where the banks have been told to extend the
repayment period so that the EMI remains the same,' he informs.
Inflation control by RBI
Till September 2008, the RBI was concentrating on controlling inflation by
impounding liquidity. In fact, between December 2006 and September 2008, the
RBI increased cash reserve ratio (CRR) by 400 basis points and the estimated
amount of liquidity impounded in the first round due to hikes in the CRR was INR
1,32,250 crores. In fact, a slew of measures to control inflation by controlling
liquidity were initiated by the RBI in the first two quarters of the current financial
year to bring down inflation from the current high levels and stabilise inflationary
expectations.
These measures led to hardening of interest rates, and reduced availability of
lendable funds with banks. A leading private bank which has the largest retail
portfolio in the banking industry was particularly hit with liquidity crunch as its
deposit growth plummeted to 6 percent last year. One of its DSA says that the bank
is not disbursing even the sanctioned housing loans, and that it has completely
stopped two-wheeler loans.
Global financial meltdown
In October 2008, the liquidity in global financial markets became scarce. The
impact of the US crisis spread quickly to Europe and reached India in the form of
liquidity crunch. Suddenly, availability of overseas funds and trade credit dried up.
Indian equity market which had seen the first round of major correction beginning
January 2008 was also not conducive for raising funds.
The second round of correction in equity market came in October 2008. In order to
meet their commitments back home, foreign institutional investors began selling in
Indian equity market, further aggravating the liquidity crunch.
IBA - Finsight Special Report
February 2009
Research Sponsors:
Retail Lending: Balancing Concerns in Difficult Times
21
The RBI had to make the U-turn and reverse the monetary control measures it had
put in place, to ease up the liquidity crunch. It also took steps to soften the interest
rates. In this scenario, for the first time after so many years, banks found that
corporates need bank credit, and are no longer able to negotiate rates below prime
lending rates, since all other avenues for raising funds have dried up. The shift from
retail to wholesale credit has started.
Imminent slowdown
Though Indian banking industry and economy was not directly exposed in a big way
to US subprime crisis, the indirect impact has begun to show. Gems and jewellery,
textiles, carpets, IT and ITES sectors, which were dependent on overseas orders
have been hit by the slump in demand in developed markets. Salaries are being
reduced and jobs are being pruned in these sectors. Fresh graduates are finding it
difficult to get jobs.
In such a scenario, demand for auto, housing, and consumer durable goods is going
down. In any retail loan, an individual discounts his future income stream. In a
slowdown, future income stream becomes uncertain, and leads to reduced demand
for credit. But, to meet his necessary expenditure and to pay the EMIs of loans
contracted earlier, individuals may resort to credit cards.
IBA - Finsight Special Report
February 2009
Research Sponsors:
Retail Lending: Balancing Concerns in Difficult Times
22
4. FINE TUNING THE RETAIL LENDING MODEL
The retail lending model which was imported by foreign banks has been largely
imitated by new generation private sector banks, and a few public sector banks. In
the light of the recent experience in the developed countries, and in India, the
model is seen to be having quite a few weaknesses that need to be addressed.
4.1 Structural deficiencies
Procyclicality
The remarkable growth of retail credit in India during 2000-05, and its quick
slowdown thereafter suggests that the retail lending model that was being followed
was either unsustainable or dependent on high economic growth. It was not
designed to withstand interest shocks, or the slowdown in economic growth rate.
Corporate greed
There is no disputing the fact that commercial banks have to earn profits for their
shareholders. But in doing so, they need to be conscious of their corporate social
responsibilities as well. The aggressive marketing of retail loans, taking some
leaves from the marketing books of hospitality, telecom and consumer goods
industry (as one retail banker had advocated during the boom period) overlooked
one small but crucial difference between retail loans and other retail goods and
services. In all other retail goods and services, the consumer has to part with his
funds - there is an immediate outflow of cash. So, he is able to make a fair judgment
between the value of the goods or services being sold to him against the cash that
he has to part with. But, in case of a retail loan being sold to a customer, it results
in immediate inflow of cash against small regular future cash outflows (EMIs). In this
case, the individual needs to have a greater financial discipline and ability to foresee
his personal financial position over the tenure of the loan.
It is the responsibility of the bank to ensure that its marketing efforts are not
resulting in a retail borrower over leveraging himself. Such over leveraging will hurt
both the borrower and the bank in the long run.
Impersonal relationship
The current retail lending model uses DSAs, call centre executives, and recovery
agents as personal contact points for the customer. For the bank, the retail
customer is just an application or account number. There is no continuity of
relationship. The DSA stops interacting with the customer once the loan gets
disbursed and he collects his commission. For the rest of the tenure of the loan the
borrower interacts with the call centre executives for any help, query, or first level
grievance redressal. If he defaults, he interacts with collection or recovery agents.
All these contacts are with a different person each time. There is hardly a person in
the bank who actually knows the customer, and vice versa.
From the efficiency point of view, this is definitely a good model. Banks have been
able to scale up their delivery capability and reach on one hand and reduce
IBA - Finsight Special Report
February 2009
Research Sponsors:
Retail Lending: Balancing Concerns in Difficult Times
23
transaction costs on the other, using a judicious mix of outsourcing, technology,
and centralised operations. But, it does not allow banks to know the soft
information about the borrower.
Lack of personal relationship and soft information results in the borrower being
treated mechanically by the banks using this model. Such banks have neither the
requisite information nor the willingness to re-phase the loan if the borrower is
facing genuine difficulties.
4.2 Country-specific deficiencies
Lack of financial literacy and credit counselling
Banks while undertaking retail lending in the fashion described above make an
unrealistic presumption that the borrowers to whom they are trying to sell loans,
are capable of 'understanding financial products, concepts and risks, and making
an informed decision about their personal finances'. The reality in Indian context is
quite different. An ill-informed customer is attracted towards well-packaged loan
products without realising the risk attached to them. They are also not well-
equipped to anticipate and manage their personal finances over long-term. Such
customers get into difficulties later, and contribute to NPAs. In developed countries,
financial advisors fill this gap.
Credit counselling is needed by borrowers who find themselves in debt trap. The
RBI has formulated a scheme for credit counselling centres to be established in all
districts of India. Some of the commercial banks have taken up initiatives by setting
up credit counselling centres.
Inadequate dispute resolution mechanisms
The existing model does not provide a convenient and effective mechanism for
dispute resolution at the bank level. Borrowers can either write mails or letters to
the bank (which are replied mostly in automated fashion), or talk to a call centre
executive who has neither the time or the skill and authority to resolve the dispute.
As a result, borrowers either suffer in silence, or approach the regulator or Banking
Ombudsman. In its latest report (2007-08) on Ombudsman Scheme, the RBI has
observed that 'one of the challenges that bank customers continue to face is
ensuring fair treatment from banks. The cases handled by the Banking Ombudsmen
reveal that bankers need to deal with customers in a more transparent manner,
particularly in making them aware of the terms and conditions of sanction and the
specific connotation associated with them right at the beginning. Reasonableness
in pricing of products by banks and their dealing with default situations are other
areas which require added focus'.
It is interesting to note that out of 47,887 complaints received by Banking
Ombudsman in 2007-08, 10,129 were related to credit cards, 757 to housing loans,
5,297 to other loans, 3,740 to charges without notice, and 3,128 to DSAs and
recovery agents.
IBA - Finsight Special Report
February 2009
Research Sponsors:
Retail Lending: Balancing Concerns in Difficult Times
24
Lack of credit history
One of the main requirements of retail credit is sharing of credit information
between lenders. One key issue in India has been the lack of a unique identifier for
each individual for maintaining his credit history. Surrogates like income tax
permanent account number or a combination of available attributes are being used
in its absence.
Though The Credit Information Companies (Regulation) Act came into force only in
May 2005, CIBIL (Credit Information Bureau of India Limited) was established in
2000. Despite the support of the RBI, CIBIL found it difficult initially to get banks to
share their positive file on borrowers. But in absence of any legal force, CIBIL had
to operate only on the principle of reciprocity. Once the RBI grants registration to
other credit information companies, the infrastructure for fair, robust and non-
monopolistic credit reporting will get established.
According to media reports, credit card issuers are now using CIBIL Data to
rationalise the credit limits in these difficult times to control defaults.
5. CONCUSION
Retail banking in India has a great potential because of the low penetration. The
existing model has been evolving with both banks and borrowers learning from
their past experience. The RBI and IBA have tried to create an equitable retail credit
ecosystem in which the interests of both the lenders and borrowers have been
addressed. The recent initiative of granting housing loans at affordable interest
rates by public sector banks demonstrates that retail credit has now become an
important constituent of bank lending.
IBA - Finsight Special Report
February 2009
Research Sponsors:
Retail Lending: Balancing Concerns in Difficult Times
Finsight Media is a niche publishing company focused on banking, financial services,
and insurance. Finsight has no tie-up with any supplier and does not assist in the
implementation of any system. We view suppliers entirely impartially, and provide
truly independent and objective opinions. Finsight Media publishes the Journal of
Compliance, Risk & Opportunity (CRO), which is a continuous source of information
for the banking industry on the areas of risk management and compliance. Finsight
Media also publishes the flagship magazine of the Indian Banks’ Association - The
Indian Banker. In addition, Finsight conducts and publishes market/survey reports
and hosts industry conferences (some jointly with the Indian Banks’ Association) as
well as topical briefings.
For further information on Finsight Media, contact:
Shirish Pathak, President
Finsight Media
EBS 104 Hillside-1
S.No. 1, Baner Road
Pune 411045, INDIA
Tel: +91 20 40788537
Cell: +91 90110 11122
eMail: [email protected]
Website: www.finsight-media.com
Indian Banks’ Association, formed in 1946, is an advisory service organisation of
banks in India. It serves as a co-ordinating agency and a forum for its 156 member
banks to interact in matters concerning the banking industry. IBA members comprise
of Public Sector banks, Private Sector banks, Foreign Banks having offices in India, and
Urban Co-operative banks. IBA’s vision is "to work proactively for the growth of a
healthy, professional and forward looking, banking and financial services industry, in
a manner consistent with public good".
For further information on IBA, contact:
Rema K. Menon, Senior Vice President
Indian Banks’ Association
Centre One, Sixth Floor
World Trade Centre
Cuffe Parade
Mumbai 400005, INDIA
Tel: +91 22 22174012
Cell: +91 9819065512
eMail: [email protected]
Website: www.iba.org.in
www.iba.org.in www.finsight-media.com