What Are Secured & Unsecured Loans
Context:
- Concern is growing over the recent spike in consumer credit, particularly for unsecured loans. The Reserve Bank of India noted in its financial stability report from July that over the previous two years, the growth rate of retail loans was nearly twice that of gross advances.
What are loans that are unsecured and secured?
- Loans that are secured by collateral—an item that the lender has the right to take—are known as secured loans. By serving as a kind of security, this asset lowers the lender’s risk and enables them to provide cheaper interest rates. Home, auto, and gold loans are a few instances of secured loans.
- Loans that are not secured by collateral are known as unsecured loans. Because of the increased risk, the lender will usually impose higher interest rates. Personal loans, credit card loans, and student loans are a few types of unsecured loans.
What does the RBI report consider to be a topic of concern?
- The fact that over this time, the percentage of unsecured loans in total advances changed from that of secured loans, is particularly concerning.
- The report also noted that, for both secured and unsecured advances, the percentage of special mention accounts (loans with past-due principal or interest) in the retail segment was 4.5% and 5.4% for private sector banks and 9.8% and 9.2% for public sector banks, respectively.
- RBI Governor Shaktikanta Das also mentioned that the central bank was closely monitoring some personal loan segments that were expanding very quickly for any indications of stress in his monetary policy statement from October.
The RBI advises banks and NBFCs to:
- The governor of the RBI gave banks and NBFCs advice on how to “address the build-up of risks” and “strengthen their internal surveillance mechanisms.”
- In response, the central bank increased the risk weights for consumer loans made by banks and non-banking financial institutions last week, with the exception of loans for homes, cars, education, and gold.
- This appears to be an attempt to restrain the excesses observed in loans to particular categories, particularly the unsecured sub-Rs 50,000 segment, to which NBFCs are highly exposed.
- Due to the NBFC sector’s reliance on bank funding, an increase in the repayment risk may have an impact on the entire financial system. (According to central bank data, household loans and borrowings from NBFCs increased from Rs 21,432 crore in 2021–2022 to Rs 2.39 lakh crore in 2022–2023)
Effects of the RBI’s actions:
- The actions being taken may result in higher capital costs for these loans, which could have an effect on the supply and demand sides of the market.
- Concerns about borrowers’ ability to repay loans may be the cause of the surge in unsecured loans, a riskier loan category, as there are signs of mounting stress.
- For instance, UBS analysts had noted that the probability of default was increasing in a recent study on unsecured loans.
- According to the report, there has been an increase in the percentage of borrowers with multiple loans, and new loan disbursements to borrowers with less favourable credit profiles have put this group “at risk of a downturn.”
Way Forward:
- It is imperative to exercise caution regarding potential hazards. Additional focused and well-considered regulatory actions could aid in reducing possible threats to the financial system. It needs to be constantly watched by the central bank for indications of stress.
