To lend or not to lend, that is the question

CBSL rate cuts of 150 bps, SRR cuts of 300 bps and liquidity injections of over Rs. 500 billion* later, the question still remains. 

“Banks need to support the economy at this critical juncture”

Of course, yes! And the way I see it, they have – already, and would continue to do so. However, support doesn’t imply “blind” lending, which would eventually rock the boat and risk depositors’ funds. 

Put your oxygen mask on first before helping others 

While banks need to go an extra mile to revive the economy, first and foremost, they need to ensure adequacy of capital and liquidity, while maintaining stakeholder confidence (specially at these challenging times). CBSL has extended tremendous support by relaxing minimum capital and liquidity requirements, providing much needed breathing space.

Easy come – easy go

Yes, lending requires liquidity (or refinance). But mere refinancing may not induce banks to lend, especially if it’s the bank who is assuming full credit risk. Money may be real and (almost) free, but unless banks have a decent expectation of getting it back (by way of loan repayments), it makes little sense for lending such in the first place.

“Heads” I win, “Tails” you loose

Banks need to ensure that easy money doesn’t induce moral hazard among borrowers. At this juncture, where everyone (including the banks themselves) is stressed, it will be little difficult to separate the wheat from the chaff. 

Irrespective of the social responsibility of economic revival bestowed upon banks, equity markets will punish banks for falling revenues and rising NPLs, i.e. stock prices of banks with lower income and higher provisions will be battered down.

Quid pro quo (you scratch my back, and I'll scratch yours)

Businesses need to be supported and economy needs to be revived. There’s no argument there. The part everyone needs to agree (or least, understand) is how to do it without rocking the boat (financial system stability). 

Banks are (quite correctly) worried about credit risk and the simplest way to conquer their fears and get credit flowing smoothly is to take a part of that risk away from them.

A clear and transparent credit guarantee scheme, uniformly applicable among large, medium and small-scale business should do the trick. Banks and CBSL (or GOSL) needs to have sizable stake of the blended credit risk to ensure mutual commitment and diffuse moral hazard. 

You can lead a horse to water but you can't make him drink

Unless the credit risk is taken away (at least partially) from the equation, no amount of rate cuts or liquidity injections would make banks “lend” – at least not with all their heart and soul.