Indian banks have been on a consumer lending spree. Should policymakers begin to worry?

The numbers are startling. Take a look at the chart.

Bank credit to industry was anaemic in 2017. It contracted in nine months of the year. And it expanded in only three months. Meanwhile, consumer credit has been on a roll over the same period, as bankers groaning under the weight of corporate defaults have switched attention to individual loans.

There is more to the story than just the different growth trajectories of these two types of bank lending. What is also important is the fact that consumer lending has been growing far quicker than the underlying nominal gross domestic product (GDP). This means that consumer credit—aka household financial debt—has in all probability been outpacing income growth. Debt is rising faster than income. That should be a flashing amber signal, if not yet a red one.

There are two important caveats that need to be mentioned here. First, bank credit to industry does not capture the entire story because companies with strong credit ratings are now going to the financial markets to directly raise either equity or debt. The past few years have seen a profound shift in corporate financing away from bank credit and towards financial instruments such as corporate bonds and commercial paper. However, the bank credit numbers cannot be ignored either.

Second, higher household borrowing is not always a red flag. Modern economic theory tells us that people make their decisions on how much to spend, save and borrow based on their assumptions of income over their entire working lives, rather than in one particular year. Individuals who are expecting robust income growth in the years ahead have the confidence to borrow today. Households also borrow to maintain consumption levels when income is volatile. A lot depends on their optimism about the future. The recent borrowing binge, however, does not seem to be supported by a rise in consumer confidence.

The growing burden of consumer debt should be seen against the larger trends on national savings. Indian households traditionally provided an overwhelming share of the total savings needed for investment activity. Their share has been coming down through this decade. The share of gross household savings—without considering debt—in the total savings in the economy dropped from 68.2% in 2011-12 to 54.2% in 2016-17, according to the national income statistics released by the Central Statistics Office. Corporate savings have grown in importance, going up from 23.9% in 2011-12 to 37.5% in 2016-17.

Should Indian policymakers worry about the financial stability implications of growing consumer borrowing? Consumer debt is still relatively small compared to the size of the economy, at around 3% of GDP, far lower than levels in comparable economies. It is not clear how much of the recent surge in consumer lending is nothing more than a switch from informal sources of finance such as moneylenders. There also needs to be more clarity about the exact nature of the consumer loans being dished out, especially the amounts given to more high-risk clients.

It is thus perhaps premature to worry about a severe economic shock in case consumer loan defaults rise, as was the case with the mortgage defaults in the US in 2008. But that does not mean that there are no worries at all. The housing market is a good place to look. In a Mark To Market column published in this newspaper in January, Aparna Iyer showed how the proportion of bad housing loans was highest for loans under Rs2 lakh. Nearly a tenth of subprime mortgages have run into trouble. In fact, there is a noticeable negative correlation between the size of loans and the possibility of default. The Indian economy has been held up by domestic consumption at a time when corporate investment activity has been weak and foreign demand for Indian goods has been insipid. At least some of this consumer spending has been powered by loans rather than income growth. It is quite likely that banks whose consumer loan books are growing very rapidly could trip over these fault lines in case incomes do not recovery quickly or if interest rates increase sharply.

In that case, the consumer loans party could end in grief.

Niranjan Rajadhyaksha is executive editor of Mint.

Comments are welcome at cafeeconomics@livemint.com. Read Niranjan’s previous Mint columns at www.livemint.com/cafeeconomics

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