High inflation, rise in borrowing costs dent household financials: report

The Subcommittee of the Financial Stability and Development Board (FSDC-SC) warned of rising inflation, coupled with rising borrowing costs, which negatively affects household financial resources and their ability to repay loans, which may have implications for lending banks.

Determining different measures of risk using individual home loan data, it found that a dual shock in the form of a simultaneous increase in inflation and lending rates could put even households with sustainable repayment capacity at risk and double the loans at risk (LaR), the board said in its biannual financial stability report. (FSR).

The price of residential assets

According to the Reserve Bank’s quarterly Residential Asset Price Monitoring Survey (RAPMS), it was noted that in March 2023, the largest share of home loans (over 40 percent) owed by households (which fall into the tax bracket) are among the top 20 companies. Income bucket percent (households with a monthly income of more than ₹ 1.40 lakh).

The average income of households in this bucket is more than 12 times that of the lowest 20 per cent (households with a monthly income of ₹20,001 – ₹42,000), while the average loan size (at around 90 lakh) is more than 5 times. As a result, the income to net income ratio improves.

Households in the lower buckets with less buffers are likely to have a harder time servicing their debt in the event of an interest rate shock and/or spending shock, according to the Financial Stability Act.

The household sector: a financial margin framework

Referring to households’ fiscal margin, which is defined as net income from estimated taxes, EMI on a home loan and spending on basic necessities, the report said households with a negative fiscal margin are more likely to experience severe financial hardship and miss out. Electromagnetic interference missiles. Higher interest rates, higher prices, or both, further exacerbate their plight.

Such loans are said to be at risk—the number of such loans (in percentage) and the share of the total outstanding loan amount are called Loan at Risk (LaR) and Debt at Risk (DaR), respectively. , which is used to measure potential risks.

Households with an EIR (EMI-to-income ratio) of more than 60 per cent are more at risk of a negative financial margin although in the lowest income group, negative margins in EIR levels of 40-60 per cent were also observed.

Households in lower buckets where primary spending takes up a larger portion of income will have less income to spend against their EMI. Conversely, in overhead bins, core expenses take a smaller percentage of net income, leaving more income that can be spent to pay EMI.

inflation effect

High inflation increases spending on basic necessities, and the ensuing cycle of tightening monetary policy leads to an increase in average monthly income, which results in a significant impact on the financial margins of households.

The weighted average interest rate for new home loans calculated for each RAPMS round shows that this simultaneous rise in inflation and the lending rate had a significant impact on household financial margins.

When adjusting spending on basic necessities with the current consumer price index (CPI) and recalculating EMI using the interest rate calculated from the last round of RAPMS, the number of negative fiscal margin loans nearly doubled, taking the number to 31.6 percent.

The increase was observed in all income groups. Even the default rate for the bottom 40 percent of income has increased dramatically to about 10.8 percent of the total loan.

A notable finding is that due to the coupling effect of inflation and rate increase, households with sustainable levels of effective rate of return (20-60 percent) are at risk of having negative profit margins. Another cause for concern is the significant impact it could have on banks’ capital.

“While the capital-to-risk-weighted asset ratio (CRAR) of the sample of banks remained above the 9 percent threshold when inflation and price hikes were not accounted for, the high rate of return of two banks with large housing loan portfolios fell below the threshold level,” in the report.

RAPMS collected data on new home loans disbursed across selected cities from 11 public sector banks (PSBs) and 9 private sector banks (PVBs) covering about 20 home loan accounts and representing about 15 percent of active home loan accounts and 35 percent of active home loan accounts. The amount of the housing loan due to the banking sector.

Sensitivity analysis

The RBI conducted the sensitivity analysis under three scenarios – Scenario 1: inflation is assumed to be at the upper tolerance level of 6 per cent with the possibility of a 25 basis point (bp) hike in the interest rate; Scenario 2: Inflation is 7 percent with a 50 basis point hike; And the third scenario: the inflation rate is 7.5%, and the rate is raised by 75 basis points.

The results indicate an increase of up to 9 percentage points in the high income rate and a consequent increase of 8 percentage points in DaR under different scenarios

However, at an overall level, these losses have a marginal impact of about 80 basis points on the total CRAR of the sample of banks. At the individual bank level, the impact is minimal with no additional banks failing.