Apr 18, 2017 11:56 AM IST | Source:

Why bank credit at 60-year low is the cloud to the economy’s silver lining

While the economy’s dependence on bank credit has fallen, there is a risk of future growth being imperilled because banks have funded capacity creation and other sources of funding are shallower.

India's bank credit growth hit a 60-year low in FY17 at 5.1 percent. But the economy continues to grow at a more than reasonable clip. The implications of this dichotomy are clear:  While the economy’s dependence on bank credit has fallen, there is a risk of future growth being imperilled because banks have traditionally funded capacity creation and other sources of funding such as bond markets are shallower and not for all.

The Second Advanced Estimates of GDP (gross domestic product) puts the GDP growth at 7.1 percent. While this points to a decline from 7.9 percent last year, it is nowhere close to the so-called Hindu rate of growth of five percent.

The ratio of nominal GDP (GDP at current prices) to bank credit that was hovering around 1.82-1.86 between FY12 to FY16, has now inched up to 1.93 in FY17. The share of bank credit in GDP that was steadily rising year-on-year has fallen for the first time.

In fact, single-digit credit growth has been accompanied by a 11.8 percent surge in deposits, sending the credit/deposit ratio to 73 percent from 77 percent in FY16. The last time the C/D ratio had fallen was in FY09, the year of the Lehman crisis.

The share of incremental bank credit in incremental GDP has fallen drastically to 24 percent in FY17 from 56 percent in FY16 and 78 percent in FY12. Simply put, last year, for every Rs 100 additional output, Rs 56 was funded by banks; this year the funding was to the tune of Rs 24.


Many experts argue that this isn’t a worrisome trend. One main reason for the massive plunge is the rising corporate bond market from where companies are tapping funds even for working capital as most of them could have been turned away by banks due to their over-leveraged balance sheets.

In fact, banks have also started accommodating companies through other sources like CP (commercial paper) and bonds.

Share of non-banking sources like NBFCs, housing finance companies and CPs has increased to 38.6 percent in March 16 from 35.2 percent in March 14. The credit dispensed by the non-banking entities have grown at a faster clip than bank credit.

That’s not really surprising given that our banking system is saddled with close to Rs 14 trillion of bad loans, including those turned bad after restructuring. This is almost 17 percent of the system. The toxic asset problem has considerably reduced their risk appetite thereby impacting funding especially to long-gestation capital intensive projects.

This trend is unlikely to reflect in the short term as the composition of India’s GDP has altered in favour of services (54 percent) and the share of industry hovers in the twenties. But the inability to add to productive capacity has long-term ramifications for growth.

If the Indian banking system opts to park the country’s household savings in risk-free assets, it might serve bank shareholders well but it would certainly be a loss for the nation, one that will become apparent only after a few years.
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