The underbelly of banking

Shylock would seem benign.

The Reserve Bank of India’s recent directive, acting on the unbridled growth of unsecured loans, is timely, but the move may actually lead to banks raising interest rates and charges. The solution lies in banks moving away from unbridled retail lending. But that may not happen because the banking system in India, overall, is taking easier routes to make its money insidiously from vulnerable segments of the population and the industry that are hungry for debt to sustain their living, and veering away from the more difficult core banking business that would help fuel the Indian economy. And they are doing so quietly and opaquely. Here are just four examples.  

Processing fees, and then some

Banks typically charge 1-3% as ‘processing fee’ for a loan to a Micro, Small and Medium Enterprise (MSME). Processing charges are opaque and mostly taken upfront and without any resistance as borrowers need the money and do not bother about the fine-print. The bank then levies charges for valuation, legal services, etc., directly onto the borrower -- after having charged them a processing fee! As an example, a bank charges Rs 1 crore as processing charge for a Rs 50 crore facility. The borrower is then levied another Rs 5 lakh for various services such as legal, valuation, etc. What is the Rs 1 crore ‘processing fee’ used for if not these processes? Why is the Rs 5 lakh charged additionally to the borrower? Note that banks and NBFCs lend about Rs 37 lakh crore a year to MSMEs. Just 2% of that is a whopping Rs 74,000 crore -- taken away from this ‘priority sector’ as processing charges! 

Even a standard product such as a two-wheeler loan carries a processing fee of 2.5%. That’s Rs 2,000 for every two-wheeler. Perhaps not much by itself, but consider that the outstanding two-wheeler loan market is about Rs 1 lakh crore. That’s Rs 2,500 crore shaved off from 25 million entry-level vehicle customers for a standardised process!    

Banks grow, at customers’ cost  

Retail and MSME together account for a business volume of about Rs 120 lakh crore per year for banks. Middlemen engaged in solicitation to bring business to the bank are encouraged by the lender to take their commissions (up to 1% for a loan of Rs 50 crore) from the borrower. Thus, the middleman receives his remuneration from a customer that he rarely visits again, not from the bank to which he is bringing business and with which he remains engaged for perpetuity. Isn’t it just plain wrong that these middlemen collect from the smallest segments commissions adding up to Rs 1.2 lakh crore annually and yet always represent not them but the bank! As an example, for a Rs 50 crore facility, at 1% commission, the middleman makes Rs 50 lakh from the borrower, who is then left to go through the fine-print himself, negotiate the terms, protect himself from any adversity during the tenure of the loan. 

Digital spot lending

This could be the Indian sub-prime story. Much has been written about fin-tech lending companies backed by funds from China and fronted by dubious local loan sharks. But there are others, some promoted by leading banks, that offer spot loans at interest rates of 25-30% and disproportionate processing fees going up to 7%. These are loans typically up to Rs 5 lakh. The size of this market is estimated to be Rs 28 lakh crore (or 25% of all retail lending) and these customers are at the borderline of what would define sub-prime. But shaving 30% of these customers in interest and charges is a highly profitable business, even if lending to a very risky customer profile that is willing to pay Re 1 for every Rs 3 borrowed! From the lender’s point of view, very simply, it can break-even even at a 33% NPA. 

For example, a customer ends up paying Rs 2 lakh as interest for a Rs 4 lakh loan for a two-year tenure, an aggregate interest rate of 50%. The penalties are extremely high and interest is blatantly charged on interest, contravening the RBI’s guidelines and compounding stress in these fringe segments. 

Look at it from the RBI’s own lens -- that household savings are at a 50-year low of 5.1%, a drop of 2% from the previous year. At the same time, RBI data also revealed that household debt rose from 3.8% last year to 5.8% this year. And, household financial assets dropped from Rs 22.8 lakh crore in 2020-21 to Rs 13.8 lakh crore in 2022-23. Get the full picture? Households are saving less, borrowing more, and even selling assets to live. Put this in context with banks growing at 15%, driven by 24% retail loans growth (double of the last year) while corporate credit growth has struggled. It is easy to see that banks are lending to a debt-hungry population that is borrowing to live. The RBI’s recent move is to stem this unbridled growth in retail loans.

Free UPI myth

Much has been written about the success of India’s digital payments system. This cannot be denied. It is amongst the best in the world. But who is using this in India? And who is paying for it? This has now become the mode of payment for many small vendors, and a billion Indians are using UPI to transact Rs 170 lakh crore monthly. But behind this is a huge IT infrastructure that needs to be maintained and for which somebody has to pay. Banks are currently managing costs by monetising big data for cross-selling products (one UPI player grew its loan book by 150% on the back of data from its UPI transactions in 2022), supported by subsidies from the government. But they are sounding alarm bells over the costs. Sooner or later, customers will have to pay for that. But as we have seen, when banks get customers to pay, it’s not just to cover costs, but to profit, too. If banks were to charge 0.1% of the value of UPI transactions as commission, at current levels, they would shave off Rs 2.4 lakh crore annually from the likes of vegetable vendors, street vendors and tiny traders, who account for the bulk of UPI transactions.

India’s banks, led by the private banks, are dangerously veering toward their poorest customers to shore up their profits by insidiously working on sheer volumes of the large, unquestioning, lower income/SME segments. 

(The writer is a former Managing Director of a Tata Company and now runs a Corporate Finance practise headquartered in Bengaluru)