The Current State of Indian Retail Finance, a Growth Engine―

As the global economy slows due to the intensifying U.S.-China rivalry, India’s robust economic growth continues, driven by personal consumption and housing investment. One reason for the strong domestic demand is the sharp increase in household borrowing from financial institutions. In light of this, a correct understanding of the environment surrounding retail finance (small-sum financial services for individuals and small and micro-enterprises) is critical for assessing the current state of and outlook for the Indian economy.

Since the Modi government took office in 2014, the environment surrounding Indian households’ access to financial services has greatly improved. This is because of the introduction of a national ID system using biometric technology, the spread of smartphones, and the digitalization of financial services. Initially, the use of digital financial services was limited to receiving government subsidies, transferring funds between deposit accounts, and making payments for day-to-day purchases. But use has recently expanded to include loans due to the introduction of services where screening can be completed via a smartphone alone and the reduction of screening costs thanks to AI (artificial intelligence). Commercial banks, mainly public sector banks, play a leading role in lending to individuals, but NBFCs (Non-Banking Financial Companies), which are subject to lighter regulation than commercial banks and are active in providing smallsum loans to low-income earners, have become increasingly prominent in recent years.

The increase in lending to individuals by financial institutions has the dual effect of boosting the economy through both durable goods consumption and housing investment, while also increasing the risk of households defaulting on their debts during an economic downturn. There are three key risks surrounding India’s retail finance. First, risks stemming from the structure of the Indian economy, such as susceptibility to external factors like weather conditions, crude oil prices, and the monetary policies of developed countries. Second, risks stemming from policy changes, such as India’s tendency to implement major institutional changes that temporarily cause economic and social disruption. Third, risks stemming from the structure of the financial system, such as the dependence of NBFCs on investments and loans from other financial institutions for their funding. Therefore, it is necessary to be alert to the risk that changes in the external environment or economic policy could trigger financial distress at certain institutions, with adverse effects potentially spreading across the broader economy and financial system.

To curb the risk of a vicious cycle between the real economy and the financial economy, the Reserve Bank of India is trying to tighten financial regulation, with its main focus on the NBFCs that are rapidly expanding small-sum lending to low-income earners. However, there are also moves to ease some regulations as lending by financial institutions is losing momentum. The Reserve Bank of India is expected to continue facing the difficult task of balancing short-term economic expansion with shoring up medium- to long-term economic and financial stability.

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