Banks’ portfolios getting increasingly skewed towards investment in G-Secs, lending to retail sector: RBI report

Banks’ lending operations may get skewed towards smaller and financially weaker borrowers in the recovery from the pandemic, according to the Reserve Bank of India’s Report on Currency and Finance (RCF).

However, larger corporates with better balance sheets will most likely move towards greater equity and low-cost debt finance.

Increased provision and capital buffer requirements, which are essential for financial stability, can lead to risk aversion in banks, partially dampening credit growth, RCF said.

In addition, banks’ portfolios are getting increasingly skewed towards investment in Government securities (G-Secs) and lending to retail sector.

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While G-Sec is a low risk investment, it carries the risk of transforming the system into ‘G-sec investment oriented banking’ if sustained for a long period,the report said. Lending to retail sector yield comparatively better returns.

However, the multiplier impact of retail lending to kick-start economic growth is likely to be less than credit to industries. Moreover, rising NPAs in the retail segment is another source of concern

The report noted that close to 35 per cent of corporate debt liability is owed to banks. 

Indian corporates deleveraged during the pandemic benefitting from the low-cost ample liquidity conditions created by the Reserve Bank, it added.

Lower thresholds for PSBs

The credit boom during 2003 to 2007 and the bust post-GFC (global financial crisis) suggests that beyond a threshold, the credit cycle generally turns down and amplifies build-up of stress in the banking sector, per the report.

Empirical evidence suggests that in the case of India these thresholds range from 16 per cent to 18 per cent credit growth,  beyond which, credit growth may lead to a rise in gross non-performing assets (GNPA) ratio.

“Thresholds are lower for public sector banks (PSBs) than private sector banks (PVBs).

“Although PSBs still claim the lion’s share in outstanding credit, much of the weakening of incremental momentum in total bank credit flows has occurred against the backdrop of elevated stressed assets in their balance sheets. PVBs have used this opportunity to increase their share in lending,”the report said.

Empirical estimates based on the average credit-to-GDP ratio (0.5), and lost growth over two years due to the pandemic led disruptions, suggest that an annualised growth of around 13 per cent in non-food bank credit will be required to achieve the target of $5 trillion economy by 2026-27 – well within the estimated threshold, per RCF’s assessment.

These estimates are, however, sensitive to underlying assumptions about variables, sample period for estimation, and the choice of methodology.

The report underscored that although the GNPA ratio is declining and provision coverage ratio is inching up, the stock of unresolved NPAs in banks’ balance sheet remains high.

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