The RBI has raised serious concerns over the risks posed by unsecured loans, which surged by 25.5% as of March 2023. While public sector banks have exercised caution in extending unsecured credit, foreign banks reported the highest exposure, followed by private sector lenders, according to the RBI data.

The RBI data shows the share of unsecured loans in total credit of foreign banks (FBs) has remained elevated, almost the same level since March 2016, with a surge to 54.2% from 53.3% in a year followed by March 2023.

"Unsecured loans, characterised by absence or inadequacy of collateral, present higher credit risk for banks in the event of a default. The share of unsecured loans in total credit of SCBs had been increasing since end-March 2015, touching 25.5% by end-March 2023," says the RBI in its latest report on 'Trend and Progress of Banking in India 2023-24'.

In November 2023, the RBI applied some regulatory pressure to curb the increasing number of unsecured loans. The central bank says after its response to contain potentially excessive risk build-up from high credit growth in unsecured retail segments, there is a moderation in credit growth, but delinquency levels and leverage "warrant enhanced vigil".

"This share declined marginally to 25.3% at end-March 2024, mainly led by PVBs, reflecting, the impact of the Reserve Bank’s November 2023 measures to contain build-up of risk in these sectors," the RBI says.

The central bank also observes that FBs saw the highest unsecured lending exposure in both the median as well as dispersion of bank-wise exposure to unsecured loans was the highest amongst FBs.

Among various bank groups, PSBs had the lowest share of unsecured advances, followed by private banks. The mean, median, as well as dispersion of bank-wise exposure to unsecured loans, was the highest amongst FBs, it says.

Elaborating on challenges faced by the domestic banking sector and NBFCs, the RBI says under the process of supervision of banks, NBFCs and other financial entities, the focus is now on early detection and pre-emptive correction.

To contain the unsecured loan build-up, it has prescribed specific limits for unsecured lending by urban co-operative banks (UCBs), boards of scheduled commercial banks and NBFCs. "Some entities have fixed very high ceilings, which need to be continuously monitored. The Reserve Bank expects the boards of REs to show prudence and avoid exuberance in the interest of their own financial health as also systemic financial stability."

In view of several irregularities observed in the grant of loans against gold ornaments and jewellery, including top-up loans, the Reserve Bank says entities were advised to closely monitor their gold loan portfolios and ensure adequate controls over outsourced activities and third-party service providers.

In cases of top-up loans, the central bank says many REs may perceive such secured loans as having lower risk but that could lead to build-up of risks. Hence, such additional facilities are often sanctioned with minimal processes and due diligence. "These practices could lead to a build-up of risks, especially during times when collaterals for such loans become volatile or face cyclical downturns."

Several reports indicate the continued presence of unscrupulous players in the digital lending space, who falsely claim association with REs. To help the customers verify the claims of a Digital Lending App’s (DLA’s) association with an RE, the Reserve Bank is in the process of creating a public repository of DLAs deployed by REs, it says.

The RBI also sheds light on increasing instances of digital fraud, saying while many such cases result from social engineering attacks on customers, there is also a rapid increase in the use of mule bank accounts to perpetrate such frauds. "This exposes banks not only to serious financial and operational risks but also to reputational risks."

The RBI says its initiative called MuleHunter.AITM, piloted by the Reserve Bank Innovation Hub (RBIH), is a step in this direction. "Another initiative in this direction is the AI/ML-based model called MuleHunter.AITM, being piloted by Reserve Bank Innovation Hub (RBIH)."