India's attack on unsecured loans hits Paytm and other fintech companies

India’s central bank has taken measures to curb increasing stress in the burgeoning unsecured consumer loan market, hitting fintech lenders like Paytm that have increasingly relied on riskier loans for growth.

The Reserve Bank of India said in November that lenders must increase the risk weight, the minimum amount of capital they must hold relative to asset value, for personal loans from 100 percent to 125 percent after data showed the proportion of late payments had risen.

The measure aims to stave off rising consumer debt and defaults by driving up the cost of capital and slowing growth for companies that have shifted to riskier credit card or retail loans in recent years because of higher margins. RBI Governor Shaktikanta Das warned banks to avoid “any form of exuberance” after imposing restrictions.

Since then, shares of Paytm, one of India’s largest fintech companies with a market capitalization of 384 billion rupees ($4.6 billion), have fallen more than 30 percent, with Warren Buffett’s Berkshire Hathaway shortly thereafter dropping its 2.5- Percentage shareholding in the company sold by order of RBI. Last week, SoftBank-backed Paytm announced it would cut small loans below Rs 50,000.

Smaller fintech lenders face an uncertain future. Another group, Zestmoney, which offered unsecured personal loans and was already in trouble before the RBI’s announcement, is being shut down, according to media reports and a person familiar with the matter. Zestmoney did not respond to a request for comment.

“There have been a lot of players mushrooming and trying to lend in the Indian digital market,” said Peeyush Dalmia, senior partner at McKinsey, warning that regulation would force some companies to collapse. “The more serious people who have been very focused on profitability and risk will start to benefit.”

The graph shows that consumer credit growth has increased rapidly in India

Unsecured loans have emerged as a major growth area for businesses in India, the world’s most populous country with 1.4 billion people, thanks to robust economic growth following the coronavirus pandemic. Sophisticated digital infrastructure and relaxed regulation have led to a boom in online lenders offering loans with interest rates starting in the low double digits.

Fintech and non-bank financial lenders emerged to cater to the millions of Indians who joined the country’s credit-hungry middle class – many of whom traditionally had limited access to the formal financial system – and wanted to buy everything from refrigerators to vacations.

Banks have also expanded into personal loans. Banks’ unsecured credit card loans rose nearly 30 percent year-over-year between April and September, compared with overall loan growth of 20 percent, according to Fitch Ratings.

According to Fitch director Siddharth Goel, this competition has forced lenders to move into increasingly risky areas, such as rural microfinance. “Everyone tried to jump on the bandwagon and lend and lend and lend,” he said. “There was a lot of equity seeking because everyone thought this was the right place.”

But early signs that consumer credit quality was starting to deteriorate prompted the RBI to intervene. According to Marcellus Investment Managers in Mumbai, the rate of personal loans at least one day overdue, which has been rising steadily in recent years, rose to 10.4 percent in July this year from 8.9 percent in March 2019.

Line chart of stressed loans (loans that are one day overdue), % shows that regulators have responded to rising personal loan delinquencies

Bajaj Finance, one of India’s largest non-banking finance companies, said in October that it had cut small-ticket lending due to signs that consumer borrowing was becoming “more careless.”

RBI regulations now require lenders to set aside a larger share of capital for the consumer and credit card loans they issue, limiting the amount of funds available for loans and increasing competition for loans.

“India is a credit-poor country, we are a consumer-driven country,” said Shailesh Dixit, the co-founder of Gromor Finance, which offers business loans to companies and individuals. Lenders “need to look at this much more carefully.” . the cost of capital will increase.”

Hardika Shah, the founder of Kinara Capital, a non-banking finance company that provides unsecured business loans, said this would likely drive up costs across the industry.

“The effect could be a liquidity crisis because people are changing their minds,” she said. The RBI announcement “was an immediate hammer blow. So obviously they must feel that the risk is big enough to take such measures so quickly.”

A healthcare worker looks at her phone against a backdrop of switchboards, with the Indian government symbol to the right

Analysts said digital lenders, which often serve as intermediaries between financial institutions and consumers, were particularly at risk. Companies like Paytm, one of India’s oldest fintech companies, have built a user base of hundreds of millions of customers through the rapid growth of cheap digital payments, but have struggled to monetize their platforms.

Paytm, which expanded into retail and merchant loans more than three years ago, said last week that it would now prioritize higher value loans. The company said personal loans below Rs 50,000 have become “very, very negligible” at 5 percent or less of its loan portfolio, compared to nearly 10 percent earlier.

Tej Shah, portfolio manager at Marcellus, however, warned that the RBI announcement and slowdown in consumer credit would make things tougher for many fintech companies.

“They have some customers, but they don’t really have a business model and don’t know how to make money from it,” he said, adding that banks are best placed to raise more capital.

“The more sustainable model is obviously the banking model. They’ve been doing this for ages, just as it should be done from a regulatory perspective. The banks will win.”