The tenor of loans is three years for the banks, but there are no such restrictions for on-lending. This could lead to asset-liability mismatches
By Amarendu Nandy & Prasenjit Chakrabarti
In the war against Covid-19, RBI has thrown down the gauntlet by announcing an ‘on-tap liquidity’ scheme for commercial banks. It has opened a loan window of Rs 50,000 crore, with tenors up to three years at the prevailing repo rate (4%). The central bank expects that targeted on-lending of the credit to manufacturers and service providers in the healthcare sector shall strengthen India’s counter-Covid infrastructure. The loans shall be classified as priority sector lending (PSL) till repayment or maturity, whichever is earlier. The scheme has some positive aspects. First, it indicates that RBI sees merit in targeted intervention policy and is cognisant of the emergent financial needs of the healthcare sector that has been at the forefront in combating COVID-related challenges. The Rs 50,000 -crore boost in liquidity amounts to around 9% of total health expenditure of Rs 6 trillion in 2019-20.
Second, the explicit directive on quick liquidity disbursement is commendable. However, one needs to see whether the terms of on-lending ensue real gains to the borrowers vis-à-vis the prevailing market rates. In this regard, the PSL tag is likely to facilitate concessional lending, being exempt from the statutory CRR and SLR requirements.
Third, the scheme creates additional earning incentives for banks, particularly those with surplus liquidity, which can be parked with RBI at 3.75% (repo rate minus 25 bps) up to the extent of disbursed loans under the ‘Covid loan book’ (that they need to create under the scheme). With the current reverse repo rate at 3.35%, the banks could earn 40 bps more on a part of their excess liquidity.
Some serious concerns however remain. First, the scheme is well-intentioned, but ill-timed. Amid the ongoing crisis, the healthcare sector needs an immediate boost to ramp up medical facilities and emergency services. The intervention will not alleviate the urgent medical infrastructure problems as credit transmission will take time. Even if disbursement timelines (30 days) are strictly adhered to, capacity expansion cannot happen overnight, as manufacturers and service providers could be saddled with political, bureaucratic, and regulatory hurdles at all stages of capacity-planning and implementation. The intervention, being reactive than a proactive one, is unlikely to be effective at this juncture, as precious time has been lost between the first wave and now.
Second, while the tenor of loans is three years for the banks, there are no such restrictions for on-lending, which could potentially lead to asset-liability mismatches. To avoid the same, if lenders, in turn, offer the loans for a shorter tenor, it might not enthuse many targeted borrowers to avail credit under the scheme. RBI’s implicit assumption appears to be that the demand for loans will be for brownfield projects only. In that case, the impact on health infrastructure, economic activity, and income will be only marginal.
Third, the intervention appears redundant as excess system liquidity already exists. Since April 2020, the average daily net liquidity absorption by RBI under Liquidity Adjustment Facility (LAF) stands at Rs 4.09 lakh crore. The year-on-year growth in bank credit and deposit was 5.7% and 10.3%, respectively, till April 23, 2021. The widening credit-deposit gap perhaps indicates that banks are not confident enough to lend to a large set of borrowers, including those in the healthcare sector, who acutely needed the desired liquidity even before RBI’s current intervention. Creating incentives for higher interest earnings on surplus liquidity is unlikely to nudge the banks to lend more in the current uncertain and volatile environment, unless the fundamental issues plaguing banks’ risk-aversion problem are adequately addressed.
Finally, the scheme does not elucidate the prerequisite credit profile of the borrowers. This may potentially create adverse-selection problems for the lenders if they fail to do due diligence owing to time and resource constraints at this juncture.
Thus, RBI’s initiative is ill-timed, but it may facilitate healthcare capacity expansion in the medium to long term, provided associated concerns are addressed in a time-bound manner.
The authors are respectively, assistant professor (economics) and assistant professor (accounting & finance), IIM Ranchi