Pain for India's lenders as small loans sour

From the vantage point of his small Mumbai jewellery and pawnbroking shop, Raju Soni has gained a special insight into the state of India's credit market over the past six months.

Low earners, who only months ago were being courted aggressively by - private banks and finance companies, have begun returning to him for small loans. That, Mr Soni says, means "they are not getting the easy loans which they used to get before".

The problem of rural debt in India was highlighted last month when the government used the budget to grant a $15bn waiver to indebted farmers.

But bankers say the debt troubles in agricultural areas are being matched by rising defaults among urban lower earners, once seen by banks as the most promising frontier for unsecured personal loans and credit cards.

These businesses comprised 17 per cent of banks' retail loans at the end of the 2007 fiscal year last March, up from 6 per cent three years earlier, and the proportion is still growing, according to Crisil, the Indian affiliate of Standard & Poor's, the ratings agency. Crisil estimates that losses in this area could rise as high as 13 per cent in the medium term from 5-8 per cent now. Leading the trend is the "small-ticket loan" segment, which covers loans of less than Rs100,000 ($2,480, euro 1,600, pound 1,230) made to blue-collar workers and the self-employed. In what is loosely dubbed India's "subprime" market, losses are expected to be in the range of 12-15 per cent.

Bankers blame this deterioration on competition from new finance groups with aggressive underwriting practices aimed at capturing market share. The flood of easy money has led to over-indebtedness among some consumers, many of whom are unused to bank credit in a system that until recently had ignored them. With interest rates of up to 60 per cent for some small-ticket loans, the unwary borrower can quickly be buried in debt.

KVS Manian, head of retail banking at Kotak Mahindra Bank [Get Quote], said his personal loan business was growing at 60 per cent a year. He said Kotak was expecting delinquencies of about 4 per cent, but the broader market could be facing losses of 7-10 per cent.

Another issue that has affected the quality of unsecured loan portfolios has been a media storm over alleged intimidatory tactics used by some loan recovery agencies (see below). This has led banks to ease collection for a while, contributing to the rise in delinquencies.

So far, few of the losses from retail banking in India have spread into the wider capital markets. This is partly because the use of structured finance instruments to repackage debt for resale to investors is still nascent in India. But it is growing fast.

Icra, a domestic ratings agency affiliated with Moody's Investors Service, found that Indian issuance of instruments such as collateralised debt obligations and asset-backed securities doubled last year to $16.4bn.

Icra last year downgraded for the first time three securitisation deals and said it had "observed a rise in the delinquency levels of the overall loan portfolios of some players".

Analysts say personal loan delinquencies have not yet reached worrying proportions. The slowdown in lending growth and rise in delinquencies is cyclical and India remains under-banked, with less than 5 per cent of the population registered as bank borrowers.

But the next six months is likely to be painful for lenders as more rashly awarded unsecured loans go sour. Many have already slowed lending to the sector.

"The really weak small-ticket loans comprise about 10 per cent of retail finance so that's not a number that is exceptionally high. But one should be ready for this number to grow," said Tarun Bhatia, head of corporate and government ratings at Crisil. For pawnbrokers such as Mr Soni, the lenders of last resort for small borrowers, that can only be good news.

Source : Joe Leahy in Mumbai

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