Banks play a vital role in economic transformation. They are the means to fully exploit the potential of economic growth by providing efficient increase and distribution of financial resources from the savings community to entrepreneurs. The current phase of the economy, when recovering from the pandemic shock, requires more proactive support from financial entities. Entrepreneurs as committed risk takers in business obtain loans from banks and accelerate business growth to ensure rapid economic growth. The efficiency with which banks perform the financial intermediation function will determine the pace of growth.
India is still a bank-driven economy where capital markets have yet to penetrate well to channel capital to the corporate sector directly from investors in the form of equity/debt instruments. Due to the lack of adequate financial knowledge and education to choose investment products, many investors depend on mutual funds which in turn provide funds for the business sector to grow.
The banking system developed well in the post-independence period after the nationalization of major banks in 1969/1980. Banks grew more significantly after the launch of banking reforms in 1991-92 – nearly three decades ago, marking the entry of the private sector banks into the new era.
Despite a large expansion of the banking system, their performance has not lived up to their potential. The credit-to-GDP ratio, a measure of credit density, rose from 24.1% in 1991-92 to 54.6% in 2020-21 in India compared to 182% in China, 148% in Vietnam, 140% in Cambodia, 125% in Thailand while the global average over the past 2020s is 99%. Credit penetration has not been impressive compared to many other economies.
Similarly, credit to the private sector fell from 21.7% of GDP to 49.4% of GDP, indicating a low appetite for risk. As a result, the sectoral deployment of credit has fallen towards industry from 48% in 1997-98 to 28% in 2020-21 while the flow has increased towards personal loans from 10.5% to 25.9%. The focus has shifted from production-oriented lending to consumption goals. Credit to the agricultural sector has not changed much, it has simply gone from 10.7% to 13.7% and from 30% to 32.3% to the service sector.
- Reasons for weak credit growth:
One of the reasons for weak credit growth – the key to accelerating economic growth is the high pre-emption of funds. The statutory liquidity ratio (SLR) was as high as 38.5% and the cash reserve ratio (CRR) was 15% until the banking reforms were activated, leaving very little room for maneuver for banks to lend. Loanable resources were limited, which inhibited credit expansion. Even within lendable resources, banks must deploy 40% of mandated credit to go to the priority sector.
The change came after the adoption of banking reforms. The SLR was gradually reduced to 18% and the CRR to 4.5%, giving banks more leeway to deploy funds in credit. Greater autonomy was granted in credit operations as well as the freedom to set interest rates on deposits and loans which had hitherto been regulated by the RBI.
Interest rate deregulation allowed banks to set competitive lending rates that benefited well-rated borrowers. After ending the base rate regime, banks now track lending rates tied to either the marginal cost of funds based on MCLR lending rates or an external benchmark depending on the industry. Many retail and MSME loans are linked to external benchmarks such as repo rates for rapid transmission of loan rates.
Poor loan repayment culture and soaring Gross Non-Performing Assets (GNPA) were another important reason for slowing credit growth. GNPAs in India reached 7.9% in March 2020 compared to 1.6% in Chile, 1.8% in Cambodia and China, 2.2% in Brazil, 3.2% in Thailand, 3.5% in the Philippines. Available data indicates that Bangladesh has 7.7 percent proximity to India. Among others, priority sector loans to micro and small entities and government-sponsored programs such as MUDRA have contributed to the increase in GNPAs.
- Strengthening of the banking system:
Along with the freedom to expand the branch network, universal banking licenses are available subject to compliance with RBI standards. Differentiated banks – Small financial banks (SFBs) and payment banks as well as a host of fintech companies have entered financial intermediation in recent years. The Regional Rural Banks (RRB), cooperative banks, continue to serve the hinterland. Some strong cooperative banks can be converted into SFBs. Non-banks – NBFCs have been granted more freedom to undertake businesses. Banks can enter into co-loan agreements with NBFCs on a risk-sharing basis.
RBI’s Internal Working Group (IWG) even advocated the conversion of well-founded NBFCs with 10 years of experience and Rs.50,000 crores in asset size into a universal bank subject to suitability and adequacy test from RBI. This IWG recommendation is pending acceptance by RBI. HDFC has already filed its request for merger with HDFC Bank. Through the concerted efforts of the banks, the RBI Financial Inclusion Index stood at 53.9 on a scale of 0 to 100 measured on three key metrics – Access, use and quality.
In order to improve the quality of assets, in addition to the enactment of the SARFAESI law of 2002, DRTs, DRATs and a host of asset reconstruction companies (ARCs) have been created. The Insolvency and Bankruptcy Code – 2016 was enacted with the formation of Indian Board of Insolvency and Bankruptcy (IBBI) to expedite debt settlement through NCLTs and NCLAT.
A state-owned bad bank – National Asset Reconstruction Company Ltd (NARCL) was also created to relieve banks from the burden of rising GNPAs. Great awareness has spread through the credit scoring system for prompt recovery of loans and resolution of distressed assets with a duly integrated system of corporate insolvency and resolution process (CIRP) as part of the IBC-2016. The ground is firmed up for the improvement of the quality of the assets.
Banks should accelerate the growth of the corporate sector. Lending to retail, MSMEs and the agricultural sector are good, but they cannot have a quick impact on the economy. The transmission impact will be slow. Banks should develop their risk appetite to lend to large corporations and large manufacturing units. Given that the capital adequacy ratio of banks is good and the quality of assets has been able to be controlled over the past two years, the focus of banks should be on raising the credit-to-GDP ratio towards 100. 55% range does not allow the industry to grow and add to GDP. Banks should also coordinate with local NGOs and other agencies to spread digital and financial literacy so that bank account holders use the banking system to borrow and repay loans on time to improve their businesses/businesses. Thanks to the reform initiatives, the banks should be in a better position to lend in order to revive the economy more quickly despite the persistent external sector risks.
The opinions expressed above are those of the author.
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