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 India's central bank has cautioned lenders at meetings held over at least the past three months about the growing risk of delinquencies on unsecured loans amid rising interest rates and high inflation, four banking sources said.

Unsecured loans – mostly personal loans and credit cards – do not carry any collateral and therefore pose higher risk. Indian banks have been growing their unsecured lending portfolio as the pandemic-induced stress began to ease.

Banks' outstanding receipts on credit cards stood at 1.87 trillion rupees ($22.77 billion) as on Jan. 27, up from 1.53 trillion rupees from a year earlier, as per the latest data from the Reserve Bank of India (RBI).

"Risks in unsecured lending has been on the RBI's radar," said a senior official at a private bank. "The RBI has privately been cautioning banks regarding such risks, asking them to tighten underwriting practices."

The bankers did not wish to be identified because they were not authorised to speak to the media.

GRAPHIC: Delinquency levels in aggregate consumer credit, https://www.reuters.com/graphics/INDIA-BANKS/klvygbkqjvg/chart.png

As per latest data available from credit information provider CIBIL and published by the RBI, as of end-September 2022, delinquency levels in aggregate consumer credit across all product categories stood at 4.3% for state-run banks and 1.5% for private banks compared to 4.8% and 2.4%, respectively, a year ago.

The RBI, according to bankers, is concerned that the sharp rise in interest rates could trigger defaults and pose more risk. The RBI did not reply to an email requesting comment.

India's rate-setting Monetary Policy Committee (MPC) has increased the key repo rate by a total of 250 basis points (bps) since May last year to tame inflationary pressures.

This has pushed up the weighted average lending rate of banks by 95 bps in the same period.

Even as the MPC held the repo rate steady at 6.50% earlier this month, minutes of the panel's latest meeting showed that members were concerned about inflationary risks warranting further hikes.

The passthrough of rate hikes to new bank loans, however, is immediate with most loans linked to an external benchmark, like the repo.

GRAPHIC: Change in Indian banks' lending rates, https://www.reuters.com/graphics/INDIA-BANKS/byprlejmqpe/chart.png

Aggressive lending can cause overheating and lead to a deterioration in asset quality if checks and balances are not maintained, a source aware of the central bank's thinking said.

The RBI has asked banks to monitor their unsecured lending portfolios, more specifically credit cards, this person added.

"The RBI's main concern appears to be that interest rates are rising, and banks' unsecured portfolio is expanding pretty fast," said another senior banker at a leading private sector bank.

"It is trying to identify early warning signals in unsecured lending to not be caught off guard later."

($1 = 82.1400 Indian rupees)