Dear Reader,
The Panorama newsletter is sent to Moneycontrol Pro subscribers on market days. It offers easy access to stories published on Moneycontrol Pro and gives a little extra by setting out a context or an event or trend that investors should keep track of. Last week, we wrote on how banks are no longer at the centre of the flow of funds to the economy. In FY25, banks accounted for a little over half of the funding that the economy demanded, which is sizeable. But since this share is down from 60 percent in FY23, it’s fair to say banks are ceding ground to other non-bank sources of finance that are primarily the capital markets and non-bank financial companies (NBFCs).
This jams up the Reserve Bank of India’s aim to foster quick transmission of policy measures onto interest rates of funding agents. Perhaps the central bank reckoned the same and announced a slew of measures spread over the next couple of years to bring banks front and centre of the funding game. In a nutshell, the measures bring down the requirement for banks to set aside capital when they lend, in turn spurring more lending. The banking regulator has given banks ample time and then some to meet newer capital rules, as the expected credit loss (ECL) method to determine toxic assets will take effect only from April 2027 and will have a generous glide path for banks to meet them.
To be fair, India’s banking system has never been better since the 2016 bad loan nightmare and the pandemic’s blow to growth in 2020. Capital levels are enviably high, bad loans are near lows, though stress has been rising of late. It won’t be adventurous of the RBI to give banks time to meet new norms.
What stood out is the promise that banks would be allowed to participate and increase their exposure to segments hitherto considered risky. A raft of circulars would be issued enabling banks to fund acquisitions, increase their participation in financing equity purchases, in lending against securities and a more principle-based approach to lending to brokers.
In essence, banks won’t be hamstrung in providing the leg-up to generate some wealth in the equity markets, should Indians wish so. The flow of funding into equities just increased.
Over the past few years, capital market agents primarily accessed non-bank lenders for financing their purchases since banks had to adhere to strict overseeing on these transactions. NBFCs have been the biggest players here and now banks can also increase their push here.
Analysts and bankers have termed this as “unshackling the banking industry”. But there are niggling concerns.
Has the RBI merely given a well-deserved freedom to banks to be the financiers of wealth creation and in turn get to influence the funding channel more or has it just found a permanent solution to a temporary problem?
Banks have healthy balance sheets, and the hysteresis of past crises has ensured that bankers remain vigilant about risks. But it takes only a spark to light a forest fire and capital markets are treacherous woods. Also, by increasing banking’s footprints into most segments, the central bank can hope for faster policy transmission. Our Chart of the Day shows that NBFCs are not upstanding in the policy transmission process compared with banks. Then again, bond markets tend to respond faster to policy rate changes than banks.
That brings us to the point we made at the beginning that banks have been losing ground in the funding game. The share of the banking sector in flow of funds has had its own ebb and flow historically. A large part of it is simply the fact that borrowers go where the rates are cheaper. NBFCs and the markets have been able to provide cheaper funds at times. But banks have been the go-to counter during uncertain times and bankers have been able to attract business away from other sources, too.
Prudential norms are hardly short-lived and tend to be at least medium-term driven. In giving greater access and freedom to riskier pockets of the economy so that banks are back in the lending game, the central bank may be stepping onto a rocky path.
RBI Governor Sanjay Malhotra was clear that the central bank wants to protect financial stability and banks must not overindulge with their new-found freedom. That said, history has enough examples to show that banks tend to get exuberant when growth rates start to show fireworks. Prudential easing and select steps to make it easy for banking customers to transact are aimed at ease of doing banking. But will it lead to ease of doing good business or just risky and easy business?
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