RBI's problem with revolving credit

**Shrehith Karkera** (0:01)
Hello folks, you're tuned in to Finshots Daily. In today's episode, we explain why the RBI wants to pull the plug on revolving credit offered by NBFCs.
But before we begin, here's a quick note from Team Ditto. This weekend, we're hosting a free two-day insurance masterclass that helps you build real financial security by understanding health and life insurance the right way. Well, the masterclass is completely free, and you can head to the link in the description to register while your seats last. Okay, let's start with the story.
A few days ago, the RBI issued a draft direction that defined revolving credit and term loan, and at the same time proposed banning all NBFCs from offering revolving credit products, except those authorized to issue credit cards. And that's caused quite a bit of chaos in the market. If you've seen stocks of large NBFCs like Bajaj, Stata Capital, Geofinancial Services and others fall over the last few days, well, you can blame this. So let's understand why this is such a big deal. But before we get there, you need to know what revolving credit actually is and why the RBI wants to pull a plug on NBFCs offering it. Think of revolving credit as a loan that is sanctioned once, but can be borrowed and repaid repeatedly, as long as you stay within your limit. Just like your credit card. Say you have a 1 lakh limit, you borrow 50,000, after a while you repay that 50k, you can then borrow any amount, up to 1 lakh again, and without having to apply for a fresh loan. Now, that's very different from a regular term loan. If you take a 1 lakh loan, borrow 50,000 rupees and repay it, you can't borrow again without submitting a fresh loan application and documents. But what's the problem with revolving credit? You ask. To begin with, there's something you may have heard in the world of credit. Evergreening. For the uninitiated, Evergreening is simply using a new loan to repay an old one, and revolving credit can potentially make this easier. Say a business has taken a 1 lakh flexi loan, which is a type of revolving credit for working capital, money required for day-to-day operations. Now, it has drawn 50k so far, but the business is under stress and can no longer comfortably service the loan. If it doesn't repay the interest or principal within 90 days, the loan could risk becoming a NPA, that's non-performing asset, which could also hurt the business' credit record. But it could still do something smart here. Since it still has 50k left on the credit line, it could draw more money from that unused limit and use it to repay part of the earlier borrowing. And just like that, the repayment gets made, the account continues to look healthy, and the business avoids being flagged as a borrower that is struggling to repay. So the loan keeps running just on paper though, but in reality, the borrower may be simply borrowing more to keep an old loan alive.
And that, you could agree, could be risky for the lender or the NBFC in this case. But here's something interesting. Even though revolving credit can potentially facilitate evergreening, the RBI has proposed to stop only NBFCs from offering it, not banks, which makes you ask if this is risky, why let banks do it? Well, there's a key difference. See, banks primarily lend money that comes from deposits they take from the public, such as money sitting in the savings account, current accounts and fixed deposits. NBFCs, on the other hand, generally can't accept deposits from the public, so to lend to the customers, they rely on borrowed money from banks or raise funds through debt instruments such as bonds. That means revolving loans can create an additional problem for them. Their cash flows can become harder to predict because customers can draw money whenever they want, repay it and then borrow again. And a customer who looked financially healthy when the facility was being sanctioned could continue drawing from it even after their financial situation has deteriorated. There's another issue too. An NBFC may only see what's happening within the credit line itself, like how much the customer has borrowed and how much they have repaid. It may not have a complete view of the borrower's overall cash position or bank account activity. To make this easier to understand, imagine a borrower is repaying one loan using another withdrawal from the same credit line. The NBFC's records could still show a clean repayment history because the money is simply coming back. But it may not know whether that repayment came from the borrower's actual income or whether the credit line is effectively being recycled. Banks can sometimes have a clearer picture, especially when the borrower already has savings or current account with the same bank. They can see salary credits, business receipts, other outflows and account balances alongside the loan. So if a business's revenue has dried up, that may show up in its account activity, even if its loan repayments still look perfectly fine on paper. And it's not as if RBI has done this out of the blue. It has been tightening the screws for a while now. If you remember, back in 2023, when unsecured consumer lending was growing rapidly, the RBI asked NBFCs to maintain a higher capital cushion for riskier unsecured consumer loans. It was worried that some of this aggressive lending could eventually turn sour. And if you look at it from the RBI's perspective, this move does make sense. Revolving credit can look a lot like a credit card just without the card. And credit cards have a separate regulatory framework. For context, NBFCs need RBI approval and a minimum net owned fund of 100 CR to issue them. So allowing NBFCs to offer credit card like products without going through the same framework could encourage weaker underwriting and potentially create a regulatory loophole. But there's a downside too. This could meaningfully affect NBFC businesses even if it isn't an existential blow. Take Bajaj Finance, India's largest private sector retailer NBFC.