Banks get the jitters as India Inc looks for funds elsewhere

Written by Sajan C Kumar | Chennai | Updated: Oct 21 2009, 05:22am hrs
Despite ample liquidity and improved demand in the market, corporates are tapping other sources of funding, giving the jitters to banks. The downward rigidity of interest rates has been a major reason behind the lacklustre credit growth in the private sector.

A robust pipeline for credit demand and the likely withdrawal of a very accommodative monetary policy by the Reserve Bank of India (RBI) may see the squeezing out of excess liquidity, according to a Standard Chartered Banks special report, India Chart Book: Q3 2009.

The current credit growth of about 12.6% was less than half the peak reached in the middle of this decade, when both investment-led corporate credit and the appetite to increase retail credit penetration were at their peak.

The report says that for the last three quarters, incremental credit offtake has been substantially lower y-o-y, and that the current rate has not been in line with the industrial growth observed in June and July. Incremental non-food credit up to September 11 was only Rs 371 billion, against Rs 912 billion for the corresponding period last year. However, the report points out that the slowdown in the private sector credit growth was as much a supply-side issue as it was a demand-side one. As the economy experiences higher consumer spending and investment, credit demand is likely to pick up.

Notwithstanding the tightening of credit standards, the policy thrust is likely to be on making available traditional bank finance to both retail and corporate borrowers. Also, the significant rise in banks credit to the government in the first half of the year is likely to be subdued in the second half, when bond supply pressures are likely to ease.

Following the liquidity crisis that India faced in September-October 2008, the central bank has been proactive in providing sufficient liquidity to the financial markets. Repo rate cuts of 425 bps have been complemented by a 400 bps reduction in the cash reserve ratio (CRR) and a plethora of innovative liquidity-injection tools.

According to RBI estimates, overall liquidity provision through different measures exceeded Rs 5.6 trillion, which is roughly 10% of Indias nominal GDP. The overall surplus daily liquidity in the banking system has been consistently in excess of Rs 1 trillion for the last five to six months; in the pre-crisis period even Rs 500 billion of excess liquidity was considered sufficient. Responding to this unprecedented monetary easing, overnight call money rates have dropped from a peak of around 20% during the crisis to about 3-3.30% now, the report points out.

However, the transmission of monetary policy to other commercial bank lending and deposit rates has been hampered by structural rigidities. The median reduction in the lending rate (PLR) during the period was 200 bps for public sector banks and an even lower 100 bps for private sector ones, against the 425 bps reduction in the policy rate. The effective lending rate reduction for fiscal 2008-2009 was only about 110 bpsfrom 12.3% to 11.2%. Similarly, deposit rates were reduced in a gradual fashion and only recently breached the administered small savings rates on the downside.

According to the report, the rigidity in the transmission of monetary policy was the result of the structure of administered interest rates, the banks dependence on essentially fixed-rate-liability products, and the upward pressure on interest rates resulting from a massive government borrowing programme. Meanwhile, current deposit growth has been strong, in excess of 20%. For the last few quarters, absolute incremental deposit numbers have been higher than in the corresponding quarters of previous years.

The report also adds that the share of bank lending of total financing to the industry declined from 43% in fiscal 2007-2008 to only 6% in the first quarter of the current fiscal. Part of the decline could be seasonal. This is because even in fiscal 2008-2009, the banks share of lending was 47%. The situation seems to be even more alarming because total financing to the industry fell by 14% year-on-year in fiscal 2008-2009 and by 43% y-o-y in the first quarter of the current fiscal. The gap left by banks and the lack of foreign funding sources has been filled by public policy support through the Life Insurance Corporation of India, non-banking financial companies, and aggressive bond and short-term commercial paper issuance by corporates.

The report expects the share of traditional bank lending channels to pick up in the coming quarters. The growth in bank credit has been quite spectacular in sectors like infrastructure (35%), construction (45%), real estate (52%), and iron and steel (30%). However, retail credit growth has been a drag. Although credit growth to small and medium enterprises was still 34%, it is down from 72% a year ago. The high deposit growth has ensured that overall money supply growth has not dropped significantly. The over-20% growth was also higher than the RBIs indicative target of 17% for the current fiscal. Although the monetary base has shrunk marginally, the growth rate of the RBIs balance sheet is much higher, at around 16% after adjusting for the first-round effects of CRR cuts.