Barking Up The Wrong Tree

It is unfair to expect risk capital from banks to prop up the economy. They deal with public money.

India’s banking regulator is upset with the extreme risk aversion of commercial banks, which are holding back the flow of credit to the productive sectors of Asia’s third-largest economy. This undermines the role of banks as the principal financial intermediary in the economy, the Reserve Bank of India (RBI) says.

However, the bankers have a different story to tell. They are not risk-averse; they are just being prudent.

Who’s right? Probably, both. Bankers are not giving credit to those who are perceived to be capable of playing a role in pushing the economic growth and creating employment as they do not find them creditworthy. And those to whom the bankers are willing to lend are not asking for money.

At the root of the debate on risk averseness versus prudent banking is a belief that credit growth can push economic growth. Can it? Shouldn’t this be the other way round — industry asks for money from banks when it wants to invest, seeing the growing demand?

Historically, whenever bank credit has been used as a vehicle for economic growth, the banks have ended up piling bad assets. This had happened in the 1990s, post the economic liberalization, and also in the recent past when after the global economic crisis, banks were encouraged to open their credit tap to all and sundry to fuel growth and in-su-late the Indian economy from the impact of the crisis.

Cheap money flooded the system and bankers merrily gave away credit to undeserving borrowers who substituted equity with debt. Essentially, the banks ended up providing the risk capital. Their indiscretion was exposed after the RBI decided to conduct an asset quality review, the first of its kind audit of banks’ books in the financial year 2016. The bad loans ballooned and eleven public sector banks were restrained from giving fresh loans.

In mid-august, the deposit portfolio of the Indian banking system was a little over 140 trillion, growing at 3.8 percent over the past year. In contrast, credit growth has been a negative 1.5 percent. The overall credit portfolio was over 102 trillion. In the last financial year ending March 2020, bank credit had grown at 6.1 percent, less than half of the previous year’s growth (13.3 percent).

The latest RBI data on credit flow to different sectors, based on the businesses of 33 large banks with 90 percent share in bank credit, show that in May 2020 loans given to agriculture and allied activities grew at 3.5 percent, down from 7.8 percent in May 2019. During this period, the credit flow to industry had gone down much sharper — a growth of 1.7 percent versus 6.4 percent. Growth in loans to the services sector and personal loans, too, has dropped.

The only segment that is seeing loan growth is the micro, small and medium enterprises (MSMES). The banks are giving MSMES money as the repayment is guaranteed by the government under a scheme. But MSMES alone can-not push up the credit growth as the banking sector’s exposure to this segment is less than one-fifth of the bank credit market. Barring MSMES, a few road projects, and some state-owned public-sector undertakings are the only takers of bank credit at the moment. Most well-rated large industries to whom the banks would love to give credit are deleveraging — they are not asking for loans.

Some believe that the fear of being hounded by the investigating agencies is contributing to the banks’ lack of enthusiasm for giving fresh credit as all accounts exceeding 50 crores if classified as bad loans, must be examined by the banks through a forensic audit for possible fraud. This may not be true. Most banks have now been following the quantitative model for risk assessment, laced with qualitative inputs. The CEOS do not take the credit calls; credit committees do.

It is unfair to expect risk capital from the banks to prop up the economy. Once there is demand and industries are willing to invest to put up factories, keeping their equity on the table, the banks must give them credit. The demand will be created only after the consumers are convinced that the pandemic is being tamed. In our fight against COVID, the government has not exactly been covering itself with glory so far.

Parallelly, the ecosystem has to be created. I am not referring to the much-discussed land and labor reforms, which ensure capital flow. There are other ways to do this. Last week, for instance, the Maharashtra government announced a cut in stamp duties and other levies for buying and selling properties in the state. It has cut stamp duty rates from 5 percent to 2 percent in urban areas till December 31, 2020, and 3 percent till March 31, 2021. For rural Maharashtra, the stamp duty rates have been slashed from 4 percent to 1 percent till December 31 and 2 percent till March 31.

This will help bolster demand for buying homes and many developers may reach out to banks for money to com-plete projects. The banks are sure to come for-ward to lend to the deserving property developers.

The buck stops with the government, not the banks. It’s unfair to expect them to be adventurous with public money. Besides, the banks themselves need capital. Most private banks have raised capital from the market in the past few months but the government has not said any-thing for public sector banks. The RBI’S annual report has harped on the recapitalization of banks as their current capital will not be enough to absorb the post-pandemic losses. The bad loans of the Indian banking system will grow substantially, the regulator has warned.