There are essentially 6 issues which need to be put on the table for debate when viewing such a policy since it sets the precedent of the government actually trying to direct credit into certain areas, which goes beyond the conventional channels of priority-sector lending.
First, there has already been a lot of debate on whether the government should be infusing capital in the public sector banks, and if it is committed to doing so, how long will this carry on. The requirements for capital are challenging looking ahead and given the constraints on the fiscal deficit, it will not be possible to keep supplying capital. Also, at some point of time, which could be after 5 years or 10, banks would be moving towards the road of hastened disinvestment not just from the point of view of operations but also to become global players. Therefore, tinkering with recapitalisation for short-term gains may not be a very good idea as it sends all different kinds of signals.
Second, directing credit to a sector beyond what is defined as priority-sector is curious. There are two issues which come up for discussion. Can we actually differentiate sectors where lending is going from the point of view of capital as money is fungible Banks can take extra capital from the ministry and map the same with existing personal loans even while using capital, which would have been allocated otherwise to such loans, for other purposes. Further, by directly linking such loans to a sector, the government would be part of the decision-making by banks, which may not be advisable. This leads to the third issue, of asset bubbles.
There are already talks of whether or not a housing bubble is building up. Property prices have risen sharply in the recent past at a time when domestic income is down, interest rates high and incomes not growing. In such a situation pushing funds aggressively to the consumer goods segment may just be tempting for banks. Also, borrowers would get a bit enthusiastic as the level of due diligence comes down. This is likely at a time when banks get free capital from the government and feel obliged to lend to a sector. Should we be aggressively pushing credit to a sector at this stage when there may be less voluntary appetite At present, personal loans (including mortgages) are one of the leading segments in terms of credit allocation. The two specific segments mentioned by the ministry, i.e. auto and consumer durables constituted just 2.4% of total loans as of March 2013. At a broader level, the question that may be posed is whether it is worth setting a precedent for a segment which is not very significant in the overall bank-lending landscape.
Fourth, there are two issues which need to be raised when talking of such funding for banks. First, are banks really under-capitalised that they are facing a problem of shortage of capital as a limiting factor The answer appears not to be in the affirmative as most banks have capital adequacy ratios of above 12%. For nationalised banks it was 12.26% in FY13 and 12.67% for SBI and its associates. Further, is there any shortage of liquidity that is coming in the way of bank lending The answer again is no, because banks have funds and are anyway preferring such lending today given that delinquencies are lower and demand is stable. Further, if at all liquidity becomes an issue, the RBI could instead just keep using OMO to shore up liquidity, which it has been doing in the last few months or enhance the LAF limits to provide more funds to banks.
This leads to the fifth issuewhether the cost of such loans will come down or not. Banks have already stated that they would have preferred the refinancing route on such loans to lower the cost of such credit. This has not been done. Further, the credit risk weight of 125% for consumer loans still remains and in case this was reduced, it could have helped to lower effective cost of such loans. Therefore, on the whole it looks unlikely that the cost of personal loans will really come down through this move.
Sixth, from a purely macroeconomic perspective, this route is quite unconventional. The premise is that we want to spur demand to boost growth. The route is not by higher spending through demand for automobiles or consumer goods keeping to the Keynesian model but providing capital for banks, which could lend 9 times that amount for such loans. As mentioned earlier, if it is not proved that capital is a limiting factor that has come in the way of enhanced credit, then this measure will merely help banks swap existing loans into this account. Also, given that the ticket size is small and that it will require several households to come and borrow at a time when job losses and zero increments are the norm, this move could at best be a sentiment-boosting step and may not actually work the way it is hoped it will.
Putting all these answers together, it may be concluded that a move to enhance capital to banks to enable more lending to specific sector may not be ideal for the system. Besides setting a precedent, it inadvertently involves the government into lending decisions of banks which may not be desirable. More importantly with the credit risk weight remaining where it is, the cost of lending may not come down and it may not quite serve the purpose that is intended, and could end up helping banks swap their funds around.
The author is chief economist, CARE Ratings