The Reserve Bank’s Report on Trend and Progress of Banking in India 2018-19 points out the stress points in the financial system and its impact on the economy, which is in the grip of a deep slowdown. The gross NPAs as a proportion of gross advances declined from 11.2 per cent in 2017-18 to 9.1 per cent in 2018-19, owing to recapitalisation of public sector banks, increased provisioning (which has impacted banks’ profits) and some recovery of dues from the IBC process. Yet, there has been a “slowdown in the flow of resources, both from banks and non-banks to the commercial sector in the first half of 2019-20”. While the slowdown has dampened demand for credit, it is also a fact that a lending squeeze by the banking sector, owing to risk aversion, is playing a significant role in slowing down the economy — setting off a downward spiral. As the report observes, banks’ confidence in lending to industry has been dented by the low interest coverage ratio of corporates; as a result, they have directed credit towards the retail segment. The report cites concern over this shift, observing that “the slowdown in consumption and overall economic growth may affect the demand for and the quality of retail loans”. While the RBI urges banks to refocus on industry, it is not clear how banks can break out of their current risk aversion, made worse by the sporadic outbreak of frauds and defaults. The incentives systems suggested by the PJ Nayak committee four years ago should be revisited.
At present, it appears that bankers would rather not lend, sacrificing a promotion or two in the process, than risk being probed for loans that go bad. The Prime Minister’s assurance that bankers will not be harassed does not go far enough. A change in the rule-book is needed. Monetary transmission has not kept pace with the 135 basis point cut in the repo rate this calendar year. Experts have pointed out that the rate cuts in 2015 led to a sharper reduction in lending rates. A reluctance to lend has kept lending rates elevated, despite subdued loan demand.
Finally, systemic concerns need to be addressed, as pointed out by Arvind Subramanian and Josh Felman in a recent paper. What began as a twin balance-sheet crisis, involving banks and infra companies, has now turned into a ‘four balance-sheet challenge’ encompassing the NBFC sector and its real estate exposures. The Centre has sought to revive real estate through a ₹25,000-crore infusion, while its efforts to ring-fence good NBFCs from the bad ones will yield benefits over time in terms of credit pick-up. Banks need more support from a more efficient IBC mechanism to push big-ticket lending. While the financial sector still struggles with governance issues, the onus rests on fiscal policy and structural reforms to spur the economy.