On the face of it, it is a conundrum why, despite the Reserve Bank of India’s repeated efforts to bring down the interest rate in the economy as well as provide more money to the financial system, banks have not been extending more loans to the broader economy.
For instance, the RBI has made it cheaper for the banks to borrow from it — by reducing the repo rate by 185 basis points since February 2019. Further, it has made it less remunerative for banks to park their funds with the RBI by cutting the reverse repo rate by 225 basis points.
However, at the count, banks had parked close to Rs 7 lakh crore with the RBI. Essentially, banks have decided to even park the deposits that they get (say from savings account holders) with the RBI instead of lending to either retail customers or businesses (also referred to as wholesale customers).
And yet, there are several sectors of the economy such as the micro, small and medium enterprises (MSMEs) that are facing acute shortage of funds especially in the wake of the COVID-19-induced economic disruption.
What explains this oddity?
To understand what is happening, one needs to break down the picture into the demand and supply sides of loans.
Chart 1 shows the credit growth rate for retail and wholesale consumers. Credit growth to businesses was already struggling for the last several years. Most of the momentum to credit growth was coming from loans retail customers were taking. These were typically being taken by individuals buying homes, personal cars, and other consumer durables like televisions, refrigerators etc.
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But, as the graph shows, even before the COVID-19 disruption in the past couple of months, demand for loans had already plummeted among businesses in the 2019-20 financial year. Retail loan growth also suffered a bit as the economy slowed down.
However, the COVID-19 impact is likely to be spectacular according to most estimates. Crisil Research estimates that while demand for new loans would remain anaemic among the business, retail loans, which were pushing up the total credit growth rate, will fall to their lowest growth rate in a decade.
Why is the demand for retail loans expected to fall?
Chart 2 shows why. Demand for most commodities for which individuals would have typically taken a retail loan is likely to fall sharply. In terms of financing penetration, almost all commercial vehicles are financed, as are 75% of all passenger vehicles, and almost every second home (new units); this dip in demand completely shuts off the demand for retail loans.
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What about the supply of loans?
It is a valid question why banks, which are flush with cheap money, are not aggressively pushing for loans in the economy.
Simply put, banks are increasingly risk-averse. Moreover, they do not know which firm will survive the COVID-19 disruption and which will flounder. The irony is that banks may be willing to give loans to the bigger firms but these companies do not need new loans because they already have excess capacity while smaller firms, which are in dire need of funds, appear too risky for banks’ appetite.
In this regard, the regulatory forbearance, in the form of a three-month-long moratorium on paying back loans, has made it difficult for banks to assess which firms are poor are managing their business and finances in this period.