Rise and fall of unsecured personal loans

Abstract

Unsecured personal loans are loans given without the benefit of any collateral. These loans are riskier than other types of loans as in the event of a default, the lender stands to lose the entire amount and has no asset it can lay claim to in place of the loan amount. As a result, these loans are given at a substantially higher rate than normal. In this report, we have traced the evolution of the unsecured loan industry from its origins as a gray market during the License Raj period, through its meteoric rise and finally its decline in recent times. Strategic inflection points in terms of delinquency, loan recovery backlash, and change from consumer durable loans to salaried account dependent personal loans have been identified. The impact of liberalization, leading to the entry of MNCs and a change in consumer mindset as well as the impact of disintermediation on the growth of the industry has been analyzed. We have also looked at the global economic meltdown as a driver behind the industry’s downfall while also examining other contributing factors such as the changes in regulations governing loan recovery mechanisms. A by-product of these regulatory changes has been a shift in focus from loan recovery post disbursement of the loan, to credit appraisal at the time of the loan application so as to reduce the incidence of defaults, as well as to reduce the dependence on loan recovery agents. We have looked at CIBIL ratings, the investors in CIBIL and the number of institutions that are registered with it. CIBIL has come up with two scores – Generic Loan score and Personal Loan score to evaluate the creditworthiness of the customer, though for a lot of banks, the use of these scores is merely a hygiene factor. We have identified this and other issues with the current system and have come up with recommendations on its improvement including addition of utility bill payments into the system and improving its integrity using the upcoming UID system. We have also tried to benchmark it against the US credit rating system. After understanding the general landscape of the industry in terms of the loans books of major players, the difference in the strategies followed by public and private sector banks as well as NBFCs (such as SBI, ICICI, HDFC and Shriram Citi) was studied in order to identify a suitable model with which to operate given the structural change in the industry. Given the success of microfinance institutions in controlling delinquencies whilst lending to people truly in need of unsecured loans, we have suggested a modified version of this model as a means of successfully competing in the unsecured loan space, particularly in small ticket personal loans.