Indian retail lending is picking up momentum again after past mistakes. According to IDFC, the segment is likely to grow at a 29% CAGR over FY10-FY12 to a whopping Rs4.2 lakh crore

India's retail loan segment is making a comeback of sorts with a changed business model and limited competition. The retail loan segment, which grew at a compounded annual growth rate (CAGR) of 50% between FY2003 to FY2008, almost went bust with fierce competition, overdependence on outsiders and regulatory changes.

This also led to exits or scaling down of operations by a number of players like ABN Amro, GE Money, Bajaj Finance, Shriram City Finance, Fullerton India and FamilyCredit.

IDFC Securities Ltd, in a research report said, "With fewer players focused on niches, pricing power seems to have returned to the financiers - who could now significantly curtail subventions paid to manufacturers and dealers. Mechanics of sourcing and collections, which are now handled in-house, have also tilted the risk-reward equation in favour of lenders. Importantly, emergence of credit bureaus like CIBIL and Experian have been a key enabler in protecting the quality of assets as lenders can now 'choose' their borrowers based on credit history.

"Going forward, we expect that the 'fresh-in-mind' outcome of cutthroat competition would prompt players to maintain a rational stance on pricing even as new players - albeit few in numbers - enter the business," the brokerage added.

During FY03, lenders used to earn a net profit of 1.7% to 3.6% for products like mortgages, car loans, two-wheeler loans, personal loans and credit cards.

 Source: IDFC Securities Ltd

However, with the emergence of cutthroat competition and price wars, the yields on consumer assets, especially for two-wheeler, personal and car loans fell 300 to 400 basis points (bps) over FY03 to FY07. Also during the so-called boom period between FY03 to FY08, lenders were using direct selling agents (DSAs) to offer the bulk of their loans.

Unfortunately, the lure of hefty commissions of up to 3% of the assets sourced made the DSAs to go in for more business without strict quality checks. This coupled with regulatory forbearance, which restricted forceful recoveries, and the cyclical economic slowdown triggered wilful defaults.

Some players who burned their fingers during this period decided to exit the retail loan segment while a few opted for the consolidation route. Globally, manufacturers subsidise lenders to reduce end-consumer borrowing costs, but Indian lenders were following the exact opposite policy.

However, with the emergence of financial recovery and credit bureaus, the retail lenders are making a comeback. "Financiers now realise that inherent product profitability leaves no room for manufacturer or dealer subventions and therefore after FY09 and later, one can find that the dealer payouts have almost disappeared across segments," IDFC said.

Similarly, the proportion of retail loans secured through DSAs and direct marketing agents (DMAs) has come off significantly to around 1% of the assets secured. In addition, retail loan lenders now prefer to source as well as collect through their own employees instead of DSAs and DMAs. This branch-banking model seems to be helping lenders to protect asset quality.

In addition, the emergence of credit bureaus, like CIBIL and Experian who provide complete information on a borrower is also helping retail lenders to choose the right customer. CIBIL, the country's largest credit bureau, covers around 16 crore loan accounts and around 9.5 crore customers, with contributions from about 255 members, including banks and non-banking financial companies (NBFCs).

India, which is home to one of the world's youngest populations, offers a perfect ground for expansion of retail loans. The country has around 48 crore people under the age of 40 years. However, the penetration of retail assets so far has remained low - at around 30%. This untapped demand coupled with the rebound in profitability for financiers, is expected to spur a boom in retail finance in the coming years.

"On the back of improving income demographics and thereby higher affordability, penetration of retail assets has been on the rise. We expect annual disbursements in the segment to accelerate to 29% CAGR over FY10-FY12 to about Rs4.2 lakh crore in FY12," the brokerage said.

According to the IDFC report, key beneficiaries of the recovery in retail financing would be Bajaj FinServ Ltd, Housing Development Finance Corp (HDFC), HDFC Bank, ICICI Bank, IndusInd Bank, LIC Housing Finance, Mahindra and Mahindra Financial Services Ltd, Shriram City Union Finance, Shriram Transport Finance and State Bank of India.