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Double challenge

Contraction of bank loans to industry is related to demand for funds and bank NPAs. Both aspects must be addressed.

By: Editorial |
Updated: October 13, 2016 12:02:20 am

The legacy of bad loans, which the Narendra Modi government inherited when it came to office in May 2014, is now taking a toll, not just on Indian banks, especially state-owned, but also the broader economy. There can be no better indicator of this than the fact that outstanding loans of scheduled commercial banks to industry contracted by 0.2 per cent year-on-year in August — the first time in at least a decade. There is both a supply as well as demand side to this contraction. The demand for bank credit by industry has slowed mainly because not too many new projects, be it greenfield or even brownfield expansion, have taken off the ground. That, in turn, is a reflection of significant underutilised capacities across most industries in conjunction with the pressure on prices, not least from imports. Both, together, have led to companies focusing more on improving utilisation of capacities — much of them created during the investment boom, 2004 to 2012 — rather than embarking on new projects requiring funding from banks. Even in the case of initial public offers made by companies in India during the current fiscal, three-fourths of the monies raised involved cashing out by existing shareholders rather than fresh capital being issued for undertaking project expansions.

But the problem is not just related to the demand for funds. Most banks today are weighed down by huge non-performing assets or NPAs from their past loans that have gone bad. The inability to recover at least part of these — including through sale of assets built up by highly leveraged borrowers — and having to make large provisions against losses from them has made banks wary of expanding their loan books. It looks like the resolution of the bad loan crisis will take much longer than what the government or even the RBI initially thought. Gross NPAs of banks rose to 8.7 per cent of their outstanding advances as on June this year. The RBI’s latest Financial Stability Report has projected this to rise further by the end of the fiscal.

The RBI appears to be gauging both the supply and demand dimensions to the crisis. Earlier, it was focusing on the supply side, thinking that a clean-up of balance sheets by banks, while painful in the short-term, would set the stage for a resumption of lending activity. But the fact that high interest rates were also a problem, leading to lower credit demand as well as adding to the debt-servicing woes of firms, was not recognised adequately. It is now showing equal concern for growth — the latest 25 basis point cut in the repo rate is a pointer to that. That is a good sign.

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First published on: 13-10-2016 at 12:02:17 am
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