Why in the News?

Financial Stability Report (FSR) 2024 released by the Reserve Bank of India (RBI) has called attention to the question of household finances and consumption loans.

What’s in Today’s Article?

• Key Highlights of FSR (Increasing Household Debt, Shift in Borrowing Trends, Consumption Loan, RBI’s Response, etc.)

Increasing Household Debt: A Cause for Concern

• The RBI's Financial Stability Report (FSR) 2024 has highlighted an alarming rise in household debt, which has increased from 36.6% of GDP in June 2021 to 42.9% in June 2024.
• While India’s household debt remains lower than most emerging economies, the rising debt-to-GDP ratio signals potential macroeconomic weaknesses.
• Debt is typically taken to acquire assets such as homes and vehicles. However, recent data indicates that Indian households are borrowing more for consumption rather than for asset creation.
• This shift raises concerns about the financial health of lower-income groups and the long-term impact on economic stability.

The Shift in Borrowing Trends:

• The RBI report presents a mixed picture regarding consumer credit.

• A significant proportion of new loans is being taken by healthy, prime borrowers, reducing the share of sub-prime borrowing.
• Rising per capita debt is mainly observed among super-prime borrowers, who are using loans for asset creation rather than discretionary spending.
• Super-prime borrowers, who exhibit the best creditworthiness, are followed by prime borrowers who, while still considered good credit risks, are one step below the top tier.
• Borrowing for consumption purposes, however, has increased, particularly among lower-income groups.

• While these trends indicate a maturing credit market, the growing reliance on loans for consumption raises concerns about the sustainability of household finances.

Consumption Loans: A Red Flag for Financial Stability

• A worrying trend in the report is the increasing share of loans taken for consumption rather than investment in assets like housing or education. The data reveals that:

• 64% of loans taken by super-prime borrowers are directed towards asset creation.
• Nearly half of the loans taken by sub-prime borrowers are being used for consumption.
• Lower-income households (earning below ₹5 lakh annually) rely heavily on unsecured credit such as credit card debt and personal loans for daily expenses.

• This trend suggests that many households may be borrowing to meet essential expenses rather than for wealth accumulation.
• In addition, rising delinquency rates in personal loans and credit card debt indicate increasing financial stress among lower-income groups.

The Multiplier Effect of Rising Debt:

• The impact of household debt on economic growth depends on how it affects consumption patterns.
• Households with lower incomes generally have a higher income multiplier, meaning they spend a larger portion of their income on goods and services.
• However, if they are burdened with debt repayments, their disposable income shrinks, reducing overall consumption and slowing down economic growth.
• Several key questions arise:

• Are households borrowing more due to income insecurity post-pandemic?
• Are financial innovations, such as BNPL (Buy Now, Pay Later) schemes, encouraging excessive borrowing?
• Will this rising debt reduce the effectiveness of future macroeconomic policy measures, such as tax cuts or interest rate adjustments?

RBI’s Response: Curbing Unchecked Credit Growth

• In response to the rise in unsecured loans, the RBI has introduced measures to slow down consumer credit growth since September 2023. These steps include:

• Tighter lending norms for personal loans and credit card borrowing.
• Encouraging banks to focus on prime borrowers, reducing the risk of default.
• Monitoring financial institutions to prevent reckless lending practices.

• While these measures have led to a slowdown in credit growth, the structural risks associated with rising consumption debt still remain.

Conclusion:

The increasing reliance on loans for everyday consumption rather than asset creation is a growing concern for India's financial stability.

While the rise in borrowing among prime borrowers is a positive sign, the financial stress among lower-income groups could pose challenges for economic growth.

Policymakers must carefully balance credit growth with financial prudence to ensure that India’s expanding consumer credit market remains sustainable.