‘Unsecured advances’ are not the reason for banks failure

It is reported that as part of increasing caution amidst growing macroeconomic uncertainties and bank collapses in the US and Europe, the RBI is asking banks in India to be watchful over their retail portfolios, particularly the unsecured loans. The direction seems to be a panic reaction for the reasons discussed hereunder.

RBI’s regulation until 2004

Until June 17, 2004, banks were required to limit their commitments by way of unsecured loans and guarantees in such a manner that 20 per cent of a bank’s outstanding unsecured guarantees plus the total of its outstanding unsecured advances should not exceed 15 per cent of its total outstanding advances.But after this, to provide further flexibility to banks on their loan policies, the above limit on unsecured exposure of banks was withdrawn. As per RBI direction “Unsecured exposure” is defined as an exposure where the realisable value of the security, as assessed by the bank/ approved valuers / Reserve Bank’s inspecting officers, is not more than 10 per cent, ab-initio, of the outstanding exposure.

Bank failures not on account of unsecured loans

Hence for the past 18 years, banks decided their policies about unsecured advances and there was no occasion that such freedom provided to the banks was considered harmful. When there are many reasons for the bank failures we have seen in recent years, like that of Lakshmi Vilas Bank or Yes Bank, we could not attribute ‘unsecured advances’ as a reason.

Secured does not mean assured recovery

If the lending is based on tangible security, it does not automatically translate into a safe and recoverable advance. Even in secured advances, the charge is created by different methods and in all types, the bank may not be able to lay its hand on the security at its will. For example, when the stock in trade is hypothecated to the banks, though the advance is secured against the stocks, the stocks are with the borrower only. He may appropriate the stock at his will. When landed properties and buildings are mortgaged to the bank, still, the properties are under the possession of the owners and there are cumbersome procedures to take over and sell such properties to realize the amount due to the banks. When machinery etc. are taken as security, these may depreciate in value and sometimes, they may be worthless though as per records, such loans are secured.

Ensuring recovery of unsecured loan

When personal loans are granted without any security, generally banks extend such loans to salaried class employees and in most cases, there is a tie-up with the employer to recover from salary and deposit to the bank for adjustment of loan. Banks insist on maintaining a salary account with them so that they can monitor the account and recover the loan amount due in time.

Moreover, these loans are small ticket loans for banks but provide higher interest income to the banks. Banks do extend unsecured loans to persons who have availed of other secured loans like home loans or Loans against government securities/Insurance policies etc.

Required for growth

Banks extending unsecured loans fulfil a major boost to the economy. While banks extend loans for manufacturing activities, the economy needs sufficient consumption for such manufactured goods and unsecured personal loans fulfil that gap. This is vital for the growth of the economy.

Unsecured advances not alarming

Finally, being a performing loan does not mean that it should be a secured one. When the borrower has debt-servicing capability and willingness to clear the loan, it is immaterial whether the loan is secured or not.

(The writer is a retired banker)