Loans against property pose increased risk as demonetisation exposes quality risk

The loans against property (LAP) segment has grown at a compounded annual growth rate (CAGR) of 25% between 2012 and 2016 as compared to 17% for overall retail credit. However, the unique characteristics of this borrower segment, combined with rapid growth and intensifying competition, are posing risks to this segment of banks' loan portfolios, a Moody's Investors Service report said.

Srikanth Vadlamani, Moody's Vice President and Senior Credit Officer, said, "Growth in LAP loans has outpaced overall retail credit growth in recent years, but relatively loose underwriting practices and a tightening in credit following India's demonetisation would translate into higher asset quality risk."

As per the report, because LAP loans are given to SMEs and self-employed individuals, a borrower's ability to repay is often based on the lender's assessment of the borrower's income (surrogate loans) rather than actual reported income (income-based loans).

Hence, with the availability of credit, it is easy for borrowers to refinance their debt. And, with this the borrowers are potentially masking any weakening in their ability to repay the debt.

Based on the risks, the 90+ days past due rate of LAP loans reached 2.7% as of March 2016 compared to 2.3% as of March 2015. But, with the withdrawal of high denomination currency, Moody's expect the risk is likely to further expose the weaknesses in this segment. 

"Disruptions in the borrowers' cash flows may trigger delinquencies, while tightening underwriting practices will make it more difficult for them to take out new debt".

Thus, the research agency predicts that the stable performance of the much larger home loan segment will mitigate the negative impact, supported also by the country's favorable demographics, growing primary market supplies and an increasingly affordable housing segment.