RBI governor raises red flag on model-based lending

livemint.com:

Edited excerpts: At the moment, the Indian banking sector remains resilient and robust. Even if you look at the unsecured consumer loans and some segments of personal loans, the numbers that we have before us are not particularly alarming. Even the NPA numbers are also within reasonable limits.

But what came to our notice were two or three points. One, as I mentioned in my address, there was a kind of exuberance which we saw that was building up and kind of a fear of missing out (FOMO). This was one opportunity which everybody thought they would capitalise on.

In this process, what was happening was that every institution, whether it is a bank or an NBFC, has a certain management bandwidth to appraise proposals, to diligently examine a loan application. Some of them have got model-based lending and there are models which automatically generate sanction letters. We saw that banks and certain NBFCs, as per our supervisory assessment, did not have that kind of bandwidth of doing due diligence of the loan proposals to justify the kind of loan growth that was seen.

It was very clear that going forward this kind of growth would not be sustainable if it is not slightly moderated. So, we clearly smelt, saw and anticipated some problems ahead of us down the road. It is for the banks to do it.

How to do appraisal is not something which the regulators should be telling the banks. This model-based algorithm or model-based lending is one area where currently we are looking at. The robustness of models is something for the bank management, board of directors, that includes NBFCs also, the audit committees or the risk management committees of these financial entities to see how robust the algorithms are and how robust the models are.