Bank credit conundrum

SA Raghu | Updated on December 01, 2020 Published on December 01, 2020

The demand seems to be for the short term

The RBI took flak for not reining in inflation and for not reducing policy rates at a time when GDP has fallen off the cliff. While its failure on inflation could be partly explained in terms of food and fuel prices being uncontrollable variables, the hypothesis that the steep yield curve (the differential between 2-year and 10-year is around 160 bps) is putting off private investment, needs examining.

At the short end, policy rate cuts are getting transmitted through to ultra-low CD and CP yields, but term premiums are high, although the RBI has been resolutely trying to keep yields low for the government. There are explanations for the steepness of the curve beyond one year — excessively low short-term rates which magnify the term differential, higher inflation and simply long-term fatigue, especially with banks that want higher premiums for financing increasing government borrowings. If bank credit is not picking up, high rates may not be the reason; we need to look at other facets of credit. The RBI’s disaggregated data provides some answers.

Individuals and government (including PSUs) are the largest borrowers (58 per cent of outstanding bank credit as of March 2020) while the private corporate sector lags behind with a share of 31 per cent. If this is surprising, the fact that long-term loans account for over 50 per cent of all commercial bank credit is even more intriguing. But more term loans did not necessarily translate into more projects and growth-contributing capital investment because these have been largely home loans and financial intermediaries (50 per cent of all term loans).

Industry’s share of long-term loans was only 28 per cent; in fact, only 19 per cent if infrastructure and basic metals are excluded, which represent past exposure of banks stepping in to fill the gap left by term lending institutions. That not much capital asset creation has happened is corroborated by data on gross fixed capital formation (GFCF), where plant and machinery account for only 35 per cent of the GFCF.

Thus, if industry is still the single largest recipient of bank credit (30 per cent), it only suggests that demand has been for short term (working capital needs) than for asset creation. Even other sectors (trade, transport and services) were working capital intensive, with a share of 28 per cent. The only long-term borrowers apart from the government were personal home loan borrowers and financial intermediaries.

Some data points

* Nearly half (47 per cent) of outstanding credit (as of June 2020) had a median interest rate of 7.5 per cent and almost 60 per cent of these were long-term loans;

* The weighted average interest rate (WAR) of total bank credit was 9.6 per cent, while it was lower at 9.3 per cent for long-term loans — the effect of ultra-cheap home loans dominating long term lending;

* Finance (8.2 per cent) and industry (9.4 per cent) had lower WAR rates than the system average.

The implicit risk premia (over government bonds) in some of these rates are only marginally higher than those in bond markets, where too, the yield gap between top-rated 10-year corporate bonds and similar-maturity government debt has been falling, according to Bloomberg. But given the large levels of stressed assets in banking, the premia seem low. Going only by interest rates, home loans today seem to carry around the same risk as lending to government!

The IMF also seems to have acknowledged the ineffectiveness of monetary policy. It is now advocating the fiscal route to governments, asking them to spend their way out of trouble. In India, many of these sectors have alternated between government and private (PPP mode) patronage, but the problems seem intractable; if it is fiscal constraint for the government, it is viability and regulatory risks for the private sector. The manufacturing sector is also hit by over capacity and falling demand. Surplus liquidity and low rates at the short end seem to be working well for short and medium credit, but with little demand for long term asset creation, a steep yield curve may not mean much.

The writer is an independent financial consultant

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Published on December 01, 2020
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