Reserve Bank of India (RBI) governor Shaktikanta Das announced a series of measures on Friday to encourage banks to lend. This comes after non-food credit growth fell to a 26-year low in 2019-20. Will RBI’s new moves encourage banks to lend more?
How did non-food credit fare in 2019-20?
Non-food credit grew 6.1% in 2019-20, the lowest since 1993-94, when it was 5.7% (see Chart 1). It’s also the third-slowest growth in the last 60 years. The slowest growth was 5.4% and it took place in 1961-62. Banks lend money to the Food Corporation of India and other state procurement agencies to buy rice and wheat directly from farmers, primarily to meet the country’s food security needs. Once this lending is subtracted from the overall lending of banks, what remains is non-food credit. Non-food credit growth was collapsing even before covid-19 struck. Since then, things could have only got worse.
How do we know bank lending has collapsed?
Take a look at Chart 2. Banks deposit their excess money with RBI. The central bank pays them a certain rate of interest on it, called the reverse repo rate. On 20 February, banks had deposited ₹39,983 crore with RBI under the reverse repo window. By 12 April, this had exploded to ₹7,01,699 crore, an increase of 1,655%. As of 16 April, the total amount deposited by banks with RBI under the reverse repo window was ₹6,99,312 crore. Some of this increase is due to a rise in government spending over the last few weeks that has ended up with banks. Clearly, banks have money to lend, but are not doing so.
What did RBI do on Friday to get the banks to lend?
As Das put it, banks need to deploy these surplus funds into productive sectors of the economy. In order to encourage them to do so, RBI cut the reverse repo rate by 25 basis points to 3.75%. One basis point is one-hundredth of a percentage point. The idea is banks would want to lend the excess money they have deposited with RBI than earn a lower rate of interest on it.
What else did RBI announce on Friday?
RBI announced a second round of long-term repo operations of ₹50,000 crore. Banks can borrow money from RBI for one-three years at the prevailing repo rate of 4.4%. The central bank will lend against government securities offered by banks as a collateral. Banks need to invest in different kinds of financial securities issued by non-banking finance companies and microfinance institutions. Since the repo rate is lower than the normal cost of funds for banks, the idea again is to encourage banks to lend.
Will all this encourage banks to lend now?
Given the prevailing uncertainty, banks are ready to earn a low return by parking money with the central bank than lend. Also, the bad loans of public sector banks remain high. Their bad loan rate was 12.7% as of September 2019. This discourages public sector banks from lending. Bad loans are loans that haven’t been repaid for 90 days or more. As the old saying goes, you can take a horse to the water, but you can’t make him drink.
News Source: Livemint