It is common knowledge that consumer credit has been growing at explosive rates in recent years. Each of us knows how difficult it is to get through a full day without having to deal with at least one telephonic offer for a personal loan from some bank or the other. The boom in consumer credit has undoubtedly done a lot of good. It has helped banks grow their business with lower default rates. It has helped large parts of the middle class buy houses and cars. The assets owned by households and banks have diversified as a result.
Each success story carries within it the seeds of its own destruction.

I realise that it seems peevish to ask pessimistic questions when access to consumer credit in India is way below the levels of comparable countries like China and Thailand. At the end of 2005, consumer credit as a percentage of GDP was about 9 per cent in India, compared to an average of 27.5 per cent in emerging Asia. Clearly, consumer credit is likely to expand for many decades to come before it finally tapers off.

Yet, there is a disturbing question: Have banks and regulators actually understood the risks they are taking with consumers?

The flip side of the great consumer credit success story is that households are now exposed to (among other things) significant interest-rate risks. A sudden spike in interest rates could lead to financial troubles, especially if this happens in tandem with a sharp slowdown in income growth and a fall in asset prices. Of course, the underlying strength of the Indian economy makes this an unlikely scenario. But who knows?

“It may be that sustainable household debt in emerging market countries might be lower than in industrial countries, as in the case of public debt, because of the higher volatility and uncertainty of income, interest costs and exchange rates,” says the International Monetary Fund (IMF) in its latest World Economic Outlook.

Not much thought seems to have gone into figuring out what the sustainable level of household debt in India could be, both from banks and regulators. The IMF describes with approval what Riksbank (the Swedish central bank) does to assess household debt sustainability. “It uses a detailed annual survey that covers household income, debt and wealth. For the analysis, households are divided into five categories based on their level of disposable income,” says the IMF.

The Riksbank then subjects this data to various stress tests to see what can happen across different income categories in case there are higher interest rates or higher unemployment. It uses this information in tandem with macro data on total household debt to assess how vulnerable indebted households are to economic shocks.

Nothing of the sort is done in India. The basic problem is that sustainability of debt and the ability to service it can be assessed only if we have data on household incomes and balance sheets. While income data is available, not much is known about household balance sheets in India. To draw an analogy with industrial lending, it is as if banks were lending to companies only with the profit-and-loss statements of companies; the balance sheets of the borrowers are not known. Does that look like the basis for sensible lending practices and regulations? But that’s precisely what seems to be happening in consumer lending.

A leading equity analyst believes that the next blowout in Indian banking will come from consumer loans. Korea has already seen a painful credit card crisis, which came in the wake of a huge expansion in card issuance between 1999 and 2002. India may not see anything like this in the immediate future, but it would perhaps be a good idea to be a little more careful. A start has been made with the setting up of credit bureaus. But the information gap is still very worrisome. The RBI and banks need to do more to try and understand the nature and dynamics of household debt in India.

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