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Responsible lending: Assessing micro behavior through macro data

Indebtedness and affordability assessment should be carried out throughout the customer lifecycle; origination, customer management, pre-delinquency, collections and debt recovery.

Ranjeet S Mudholkar | August 11, 2017 | Updated 15:28 IST
Responsible lending: Assessing micro behavior through macro data
Ranjeet S Mudholkar, CFP

There is no gainsaying the fact that financial institutions and banks necessarily are held accountable to a wide range of stakeholders. This is particularly true in respect of trends in lending habits and the relationship with the existing social and economic fabric of a country.

Indebtedness and affordability assessment should be carried out throughout the customer lifecycle; origination, customer management, pre-delinquency, collections and debt recovery. Financial institutions should use affordability assessment within automated and manual decision making processes based on macro data and that fits into broad patterns drawn from households' borrowing behavior.

In the case of India, the country-wide data on household indebtedness can offer meaningful insights into how banks and financial institutions can become more responsible lenders and prevent families from falling into a perpetual debt trap. The Incidence of Indebtedness (IOI) in India as of 2013 (the latest for which data is available) was about 31.4% among the rural households and 22.4% among the urban households.

The Average amount of Debt (AOD) per indebted household was Rs. 1.03 lakh in the rural and Rs. 3.78 lakh in the urban areas. Contrary to the logic, as people get richer, they are more likely to be in debt, and the size of their loans grows too. Amongst the richest 10% of rural Indians, the average outstanding loan of an indebted household is over Rs. 12.5 lakh.

Land and building together, both in rural and urban areas, accounted around 90% share in the total value of assets at the national level for all households. On average, debt-toasset ratios in India are still low (8.5% in rural areas and 14.8% in urban areas) compared to global averages.

In India, the household debt is mere 10% of GDP, amongst the lowest in both the developed and top emerging economies. It is noted that the southern states are significantly more indebted than the rest of the country; with nearly half of all households in Andhra Pradesh, Telangana, Karnataka and Kerala have outstanding loans.

In the rural areas, the non-institutional agencies played a greater role in advancing credit -they accounted for 19% of households, while the institutional agencies had advanced credit to 17% of households. In urban India, the institutional agencies played a greater role, advancing credit to 15% of households against 10% by non-institutional agencies.

The share of debt in the rural areas was 56% institutional compared to 44% noninstitutional. In urban areas, this ratio was 85% from the institutional credit agencies against just 15% from the non-institutional agencies. In rural areas, co-operative societies and commercial banks were almost equal in advancing credit and together accounted for 50% of the outstanding cash debt.

In the non-institutional credit, "professional moneylender" was the most important source of finance accounting for over 28% of the outstanding cash debt. Against this, in urban areas about 75% of the outstanding cash debt in urban areas was from institutional 2 agencies, banks accounting for 57% while co-operative societies 18% of outstanding cash debt. The "Interest-free" debt was 8.5% in rural and 4.5% in urban areas of the total respective outstanding debt.

The most common purpose of a loan in rural as well as urban India is for "other household expenditure" which includes weddings and the purchase of household assets. In rural India, loans for farming are the next most common purpose. In urban India, medical treatment is the next most common purpose of a loan, especially among the poorest urban households. For the poorest in rural areas as well, it is medical treatment that seems to be is pushing people into debt.

The housing loans are the most common among the richest. Personal security accounted for highest share (20% in rural and 12% in urban) among the types of security against loan followed by 6% in rural and 5% in urban against mortgage of immovable property. Among the terms of interest, simple rate of interest was predominant rate in practice for both in rural (20.3%) and urban (13.4%) households.

This information and analysis plays a critical role in defining the affordability assessment process of a lending institution. There are instances where consumers often face aggressive, predatory selling practices of institutions, and are pushed into buying complex products that they ill afford and do not understand.

Disclosures are either after the fact, or hidden in legal jargon in fine print in contracts which consumers are pressured to sign in haste. It is absolutely necessary to publish standard form agreements that clearly explain the terms and put the pricing structure in the public forum.

The writer is working with Financial Planning Standards Board India (FPSB India) in the capacity of Vice Chairman and Chief Executive Officer. The views expressed here are personal, and do not necessarily represent that of the organization. FPSB India is the sole marks licensing authority for the CFP marks in India, through agreement with US-based FPSB Ltd.

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