Healthy banks ≠ healthy household finances

The Reserve Bank of India’s latest Financial Stability Report is reassuring about the health of banks and non-banking finance companies. It is, however, less reassuring about the financial health of their retail customers.

India’s household debt had reached 45.5 per cent of GDP by September 2025, close to its earlier peak, and scaled a new high of 47.8 per cent by December 2025. This may not be exceptionally high by international standards, but beneath the headlines lurk signs of stress, revealed by the purpose of the loans, who the borrowers are and what they are pledging to get the loans.

Non-housing retail loans now account for 58.4 per cent of household borrowings. Nearly half of all household debt is classified as borrowing for consumption, as distinct from asset creation or productive activity. A housing loan creates an asset, while a business loan may create an income stream. Even an education loan creates future earnings. But a personal loan used for groceries or medical expenditure or repayment of an earlier loan does none of the above.

The distribution of stress is even more revealing. As per the RBI study of 10 large banks, covering nearly 90 per cent of such lending, those with annual incomes below Rs 10 lakh accounted for roughly three-fourths of loan originations. They also accounted for 78 per cent of fresh non-performing loans in December 2025. This foretells a household-debt crisis.

Ironically, corporate loans are doing fine, making the NPA ratio quite low in the aggregate. But a low NPA ratio should not hide the fact that the residual stress is overwhelmingly concentrated among those with the least capacity to absorb it.

Microfinance credit declined for seven consecutive quarters till January this year. The borrower base shrank by another 22.7 lakh. The fall in microfinance lending was not because poor households did not need credit. It followed from regulatory action.

Due to a phase of rapid lending, multiple borrowing and rising delinquency, the microfinance industry imposed its own guardrails. The permissible number of microfinance lenders to one borrower was eventually reduced to three. Total microfinance and unsecured retail debt was capped at Rs 2 lakh, and lending was prohibited to borrowers with payments overdue for more than 60 days. Banks also sharply reduced their microfinance portfolios. These were two very difficult years for microfinance.

Hence credit demand migrated to gold loans. Gold loans have grown at a compound annual rate of 42.4 per cent since March 2024, almost twice the pace of overall non-housing retail credit. The RBI finds that much of this increase has come from existing customers using higher gold prices to obtain larger loans and roll over previous debt.

The RBI permits a loan-to-value (LTV) ratio of 85 per cent for consumption loans up to Rs 2.5 lakh. This higher limit for small loans was intended to improve credit access for the really poor. But an 85 per cent LTV leaves a thin safety margin if gold prices drop. The RBI had already found irregularities in gold appraisal, monitoring, auctions and adherence to LTV norms, prompting tighter directions.

A gold loan is safer for the lender than an unsecured microfinance or personal loan because of the collateral. It is not necessarily safer for the family. In case of default, the lender can auction the jewellery. Thus, the banking system may report better asset quality because the risk has been shifted to the borrower. Gold is often the family’s final emergency reserve. Monetising it repeatedly to repay earlier loans is not financial deepening. It may be distress in the garb of formal credit. It is often a coping mechanism.

The evidence clearly shows some substitution of unsecured personal loans with gold loans. It is possible that microfinance loans are being replaced by gold loans to some extent.

Loans are liabilities, while savings are assets. Net household financial saving had fallen to 5.2 per cent of gross national disposable income in 2022-23, a multi-decade low. It has now risen to 7 per cent in 2024-25, mainly because new financial liabilities declined. Gross financial saving is 11.8 per cent.

The rapid growth in borrowing is pulling down net financial savings. The earlier fall from 11 per cent to 5.2 per cent was a post-pandemic correction and not really a sign of impoverishment in the aggregate. But now it is clear that low-income borrowers are increasingly using fresh loans to pay for consumption or an instalment of a refinanced old loan.

Do cash transfers to women lead to low savings? These transfers reach 12 crore women across 15 states. A transfer increases disposable household income, improves welfare and financial inclusion. Transfers usually fund consumption — food, healthcare or children’s needs. They could just as plausibly reduce dependence on high-cost borrowing. But it is unlikely that transfers are responsible for the decline in the net savings of low-income households.

The emerging macroeconomic danger must be acknowledged. Debt-financed consumption supports demand today but debt servicing subtracts from consumption tomorrow. A fall in financial savings reduces the domestic pool available to finance investment, to bank deposits and to fund the fiscal deficit.

A gold-price correction could simultaneously weaken collateral and expose borrowers who have repeatedly refinanced. Since the stress is concentrated among lower-income households, it can also widen the effects of inequality.

The solution is not to shut vulnerable households out of formal credit. Appropriate regulation, proactive credit bureaus providing real-time information on a borrower’s total exposure, lenders assessing repayments across microfinance, personal and gold loans can help. Repeated gold-loan rollovers should be curtailed.

Distressed borrowers need credible counselling and restructuring options. But all these measures can only contain the symptoms. Periodic loan waivers — most familiar in agricultural credit — are not durable solutions either. They transfer the burden to taxpayers, weaken repayment discipline and do nothing to repair the underlying weakness of household incomes.

Escape from excessive household indebtedness is largely outside the scope of monetary and credit policy. It requires faster growth in real wages, more secure employment, lower out-of-pocket spending on health and education and stronger protection against sudden income shocks.

Credit can bridge a temporary gap between income and expenditure; it cannot substitute income. When households must repeatedly borrow to sustain regular consumption or repay earlier loans, financial inclusion begins to camouflage financial fragility. That bank balance sheets are looking healthy when vulnerable borrowers are pledging their last financial cushion is not a healthy sign.

Ajit Ranade is a noted economist. More of his writing here

Article courtesy: The Billion Press