RBI’s credit card curbs are a classic case of ‘prevention is better than cure’

The numbers for the US paint a worrying picture. Credit card debt has crossed $1 trillion, or almost 4% of America’s nominal GDP for CY23. The 2008 subprime mortgage crisis involved a similar amount – $ 1.3 trillion – and a credit card debt crisis cannot be ruled out if the current trend continues, despite the greater cushion the US now has because of the growth of its economy since 2008. With the average credit card interest rate rising steadily to more than 20% over the past two years in tandem with the US Federal Reserve hiking interest rates, this debt could end up costing Americans dearly.

Against this backdrop, the RBI’s measures to avoid a similar situation in India are welcome. In November the central bank decided to check the growth of the credit card market by raising the risk weight on banks’ exposure to the segment to 150% from 125%. Simply put, banks now have to set aside more capital for outstanding sums on credit cards.

The regulator further tightened its scrutiny in March by issuing strict guidelines for co-branded credit cards, such as prominently displaying the name of the issuer bank, to prevent unauthorised entry into the tightly regulated segment. It barred Federal Bank and South Indian Bank from issuing fresh co-branded cards. Several fintech companies and non-banking financial companies (NBFCs) have been looking to participate in the lucrative credit card business through co-branded cards with banks as they can earn an upfront activation fee and a portion of interchange fee for the lifetime of the card. This could be one reason why companies diluted the due-diligence process while sanctioning new cards.

Notwithstanding the size of the credit card industry, there are valid reasons for the RBI’s strict action, going by the provision for the default rate (commonly called credit cost) of SBI Cards and Payment Services Ltd, India’s only listed pure-play credit card company. Even in an economy that is on a solid growth path, SBI Card’s net provisioning cost stood at 5.9% during 9MFY24, up 172 basis points year-on-year.

Banks do not reveal their credit card provisions separately, but SBI Card’s formidable position in the industry (it has a 19% share of active credit cards, second only to HDFC Bank) means it may well be representative of industry-wide trends. The credit cost for SBI Card is much higher than the overall credit cost of less than 1% reported by its parent SBI for 9MFY24. This is because even though unsecured loans have high interest rates to account for a high rate of default, the actual default rate is even higher than these interest rates warrant.

But why are default rates high? The answer to this seems to be overspending and other behavioural issues, at least in the case of SBI Card. After all, 62% of its active card holders are salaried employees, with the majority of these working at public companies or top-rated private companies where the risk of losing jobs is low. Also, 58% of cardholders have been sourced from SBI, which means the company has more than enough data to analyse before sanctioning a card. 

Underwriting or risk-assessment standards have also been above average as the company generally issues cards to those with a Cibil score of more than 700. The highest possible score is 900 and the lowest is 300, and those with a score of 700 or higher are generally considered to be responsible borrowers.

The number of credit card holders in India has almost doubled in the past five years to more than 100 million. While the RBI’s actions could slow this scorching pace of growth, allowing unregulated growth could lead to bigger problems. It’s a classic case of “prevention is better than cure”.