RBI must regulate risky loan apps, cooperative banks. They are plaguing the banking sector

The act of banking involves a social responsibility that the banks must honour on their own, without the RBI forcing them to.

RBI file photo | Wikimedia commons

The Reserve Bank of India and the Ministry of Finance have effected a remarkable turnaround in the banking sector, by reducing non-performing assets and increasing profits. But good work begets more work, and now the central bank has to shift its focus from the macro fundamentals of the banking sector to more micro issues that are plaguing it. 

These include bringing the myriad loan apps within the RBI’s regulatory ambit, more effectively reining in unethical loan recovery practices, overhauling the regulation of cooperative banks, and figuring out ways to recover more from written-off loans.

At the same time, banks and non-banking financial companies (NBFCs) must also overhaul their thought processes and internalise the fact that they cannot operate as purely profit-driven organisations. The act of banking involves a social responsibility that they must honour on their own, without the regulator forcing them to. 

Regulating loan apps

Let’s start with the changes that the RBI must make. The first relates to the loan apps. At the moment, these apps are preying on the financially illiterate and the desperate by promising no-strings-attached loans at exorbitant interest rates. The RBI does not regulate them, and they take advantage of it. 

People borrowing from such apps often default on their loans, or borrow more to repay the initial loans. 

The RBI has rules regarding the appropriate behaviour of loan recovery agents acting on behalf of its regulated entities. These rules, of course, do not apply to entities that are not regulated by the RBI, including the loan apps. Defaulters are harassed, often physically as well as mentally through incessant phone calls and threats.

There’s a dual purpose behind bringing these apps within the purview of RBI’s regulation. The first is to set some limits on the usurious interest rates. Yes, usually, the loan agreement is signed willingly, but some leeway must be given to borrowers who are too financially illiterate to even know that there could be fine print in the agreement, let alone understand what that fine print says.

The second reason is from a broader economic policy perspective. The central bank has been raising the alarm over the rise in unsecured loans for a while now and recently took action to curb this growth. But if we don’t know how much is being lent by these loan apps, that leaves a hole in our understanding of the credit activity in the economy. Getting a handle on this data will allow policymakers to better estimate how much borrowing is happening due to income distress, how much is being borrowed for consumption, and how much is being defaulted on.

Regulation of cooperatives

Back in 2020, the RBI became the sole regulator of urban cooperative banks. Since then, it has found numerous shortcomings in the way these cooperatives have been doing business and has fined several for them. ThePrint has shown through data, as well as in reports from the ground, how the operation of urban cooperative banks continues to be largely opaque, politically-influenced, and unprofessional. The data-based report can be accessed here and the ground report on this link. 

It’s time for the central bank to apply even greater rigour in the regulation of cooperative banks. These banks offer a vital banking service for people who don’t have access to banks and NBFCs. These cooperatives are also often misused by local politicians looking for easy loans. Having cleaned up indiscriminate lending by public sector banks, the RBI should now actively do the same with cooperatives.

The third area that needs urgent and focused attention from the RBI, and possibly even the Ministry of Finance, is the issue of loan recovery agents. The RBI’s rules are clear—borrowers can’t be harassed either in person or through phone calls and emails, and can’t be intimidated or harmed. The reality, unfortunately, is equally clear. 

A brief look at social media and online forums is enough to show you the enormity of the situation—thousands of people cry out for help every day. Some are harassed and viciously abused on the phone, others face more serious consequences. The harassment and violence don’t stop with the borrowers; instead, it extends to their families and friends.

The RBI and central government need to urgently and forcefully clamp down on this. Defaulters cannot be allowed to go scot-free, but beating them up isn’t going to make them pay the money back. All it does is drive the victims to informal lenders—loan apps, for one, and loan sharks—who then drive them further into debt. 

Finally, the RBI needs to really figure out a way to recover more from written-off loans or reduce the amount that is written off by banks every year. 

Write-offs increased to Rs 2.09 lakh crore during 2022-23, up from Rs 1.75 lakh crore in 2021-22 and Rs 2.02 lakh crore in 2020-21. The government has defended this by stating that write-offs are technical requirements as mandated by the RBI and that the recovery process on these loans continues. 

While that’s true, it holds weight only if recoveries actually happen to a satisfactory degree. Failing this, the process loses credibility and attracts criticism of being just another form of loan waiver. 

Fortunately, recoveries from written-off loans have been improving. In 2022-23, banks recovered 22 per cent of the value of the loans written off that year, up from 19 per cent in 2021-22 and 15 per cent in 2020-21.

This improvement is creditable but if the write-off process is to be credible, the growth in recoveries has to comfortably outpace the growth in written-off loans.

That is, if the RBI can’t encourage banks to improve the pace of recoveries, it must ask them to slow the pace of write-offs. 

Banks must embrace responsibility

Now, all of this is what the RBI needs to do. There’s also quite a bit the banks and other lending institutions themselves must do, key among which is a stronger embrace of the vital social function they perform. It can’t be that the RBI must constantly force them to do the right thing.

For example, in the wake of the withdrawal of the Rs 2,000 note, the RBI noticed a surge in liquidity within the banks as people deposited their notes. In order to absorb this liquidity during a period of high inflation, the RBI gently encouraged banks to deposit their excess with the central bank. 

It did not work, and so the RBI was forced to bring out the stick in the form of the incremental cash reserve ratio (I-CRR) it announced in August this year. This isn’t a tool often used by the central bank. It forced banks to place their excess liquid cash with the RBI.

It should not have come to that. The central bank has shown itself to be an able regulator, alert to emerging stress. If the RBI is saying that excess liquidity could lead to higher inflation, banks should have been quicker to fix the issue, rather than choosing to invest that cash in instruments that could generate higher returns for them.

Similarly, the RBI has periodically been warning banks and NBFCs about the sharp growth in unsecured loans and asked them to be alert to the stress this could create. These warnings were ignored, and unsecured loans continued to grow rapidly. The RBI was again forced to take steps, in the form of higher risk weights assigned to unsecured loans. Again, why did it have to come to enforced action? 

Banks, even private sector ones, can’t be so overwhelmingly driven by profits. If they want to be treated like institutions of significance, they must act like it.

The RBI still has a lot to do, and can’t coast on past success. But the banks and NBFCs, too, need to introspect about their vital role in the economy and society.

Views are personal. 

(Edited by Ratan Priya)