MANAGING CREDIT IN INDIA- PART II- BANKING SYSTEM AT THE CROSSROADS

MANAGING CREDIT IN INDIA- PART II

(In Times of Disruption Caused by Covid-19 and Economic Lockdown)

BANKING SYSTEM AT THE CROSSROADS

Banking System Dominates Credit in India

In Part I of this Series, we noted that credit outstanding to the final users- governments, businesses and households- in India is about Rs. 300 lakh crore or approximately $4 trillion, which makes up 150% of our estimated GDP of Rs. 200 lakh crores.

Banks are the principal providers of credit. Banks, including RBI, in direct credit mostly, have about half of the total outstanding credit i.e. about Rs. 150 lakh crores.

At the end of just concluded financial year 2019-20, total outstanding credit provided by the banks directly to businesses, governments and households was about Rs. 130 lakh crores. This comprised credit to businesses of about Rs. 68 lakh crores, to governments of about Rs. 37 lakh crore and to households of about Rs. 25 lakh crores. In addition, the banks had lent a little less than Rs. 10 lakh crores to the NBFCs, HFCs and other financial intermediaries.

RBI primarily discharges the public policy functions of regulation and supervision of the banks and non-banks besides laying down monetary policy and managing the monetary system. Reserve Bank of India is a bank as well. It is the banker to the government and it is bankers’ bank. RBI can provide banking facilities to businesses and financial intermediaries.

RBI had, at March end 2020, credit outstanding towards government only- of about Rs. 10 lakh crores. There was no credit outstanding to businesses, non-banks and households. Banks, on the contrary, had net deposits with RBI.

In this part we discuss disruption caused by Covid-19 and the consequential economic lockdown imposed in the country and their implications for the banking system.

How is the RBI managing the liquidity, credit and solvency of banks in this troublesome hour?

How are the banks managing their credit portfolio and impending larger non-performing assets?

Whether the banking system will be able to deliver credit to businesses during this most testing time is an important question to ask.

Bank Credit to Businesses   

Total outstanding bank credit (other than to governments) was Rs. 103.72 lakh crore as on 27^th March 2020.  There was growth of Rs. 2.67 lakh crore in the month of March 2020 only.

Bank credit to businesses and households increased by 6% or by about Rs. 6 lakh crores in the entire year 2019-20. This was one of the lowest rates of growth of bank credit in India in many years. Banks lend to different categories of businesses- agriculture, industries and services- and provide personal loans to households.

Current data of sectoral deployment of bank credit is available with a lag of about one month, that too, for ‘about 90%’ of the outstanding bank credit.   For the present, sectoral deployment details of Rs. 89.90 lakh crore gross bank credit are available.

Outstanding credit includes ‘food credit’ of measly Rs. .65 lakh crore. It is difficult to understand why bank credit is still presented into two major groups of food credit and non-food credit, when the food credit is not even 1% of outstanding bank credit.

Outstanding loans to businesses, out of Rs. 89.90 lakh crore, were Rs. 64.48 lakh crore. Business credit included agriculture and allied sector credit of Rs. 12.20 lakh crore, credit to industry of Rs. 27.93 lakh crore and to services of Rs. 24.34 lakh crore.

Services loans included credit of Rs. 7.04 lakh crore to NBFCs. Excluding credit to NBFCs, banks credit to real economy businesses amounted to Rs. 57.44 crore. If we keep apart credit of Rs. 12.20 lakh crore to agriculture, the manufacturing and services credit was only Rs. 45.24 lakh crore.

A good chunk of banks credit to businesses- over 15% i.e. over Rs. 10 lakh crore- is non-performing. Banks also have about 3% of their business loan portfolio stigmatised as frauds.

The remaining credit of Rs. 25.32 lakh crore was for personal loans. These loans to households have very low default rate.

The credit outstanding at end February 2020 between non-financial businesses, financial intermediaries and household credit was in the ratio of 64%, 8% and 28%. If we apply this ratio to the total bank credit outstanding at end March, 2020, banks’ outstanding credit to non-financial businesses would be Rs. 66.38 or lakh crore.

Difficulty in Assessing Impact of Economic Lockdown on Businesses

Covid-19 and the economic lockdown ordered by the government to save lives has jolted the business loans portfolio of banks. This will definitely result in a major rise in their non-performing loans as a number of shuttered businesses and disrupted businesses will fail or become loss-making. This would also create temporary difficulties in loan servicing for healthier clients as well. There would also be additional financing requirements for the businesses which can be revived and the businesses like digital economy businesses which possibly will emerge winners.

The banking system is an ongoing loop of savings, credit and service of credit. If any part of the loop gets in turbulence, others are also affected. The banking system in India was quite fragile even before Covid-19 struck. Covid-19 and the economic lockdown has disturbed the fragile equilibrium of banking system massively.

Economic Census 2013 counted 5.84 crore business establishments in India, excluding crop production and public administration establishments. These businesses employed approximately 13 crore people. These establishments are estimated to have grown to about 8 crores now.

We do not assign a unique identification number to each business and as a consequence, we do not collect economic details for each business- value added, number of workers, profits made, loans taken etc. Budget announcements have been made time and again to assign unique ID to each separate business. If every business in India- own account, micro, small, medium or large- is provided a unique identification number, it would help collect vital economic performance data and facilitate linking of all bank accounts of a business to unique ID.

One of the reasons being cited for inability of the government to announce any survival and revival package for even MSMEs is the unavailability of data about these businesses. Absence of survival and revival fiscal package has left the businesses which have credit from banks entirely at their mercy.

It is absolutely necessary that India initiates the allotment and management of unique ID number system for businesses. We have enormous experience in constructing the biggest individual unique ID system in the world. That experience should be put to use for creating the unique ID system for 8 crore businesses of India.

Broader Assessment on Bank Credit to Businesses

Covid-19 and the economic lock-down has impacted non-essential non-agricultural enterprises most. All businesses producing ‘non-essential’ goods and services have remained shuttered completely for a month. It is difficult to say when the non-essential businesses would get back to normal. Some of these businesses may never become normal.

An examination of published data of outstanding credit at end March 2019 (which provides data for entire bank credit and not 90%) for major business categories, excluding agriculture, suggests that outstanding banks credit is overwhelmingly towards the ‘non-essential’ businesses.

Outstanding loans to the exclusively ‘essential’ industries groups- ‘food manufacturing and processing’, ‘electricity, gas and water’ and ‘IT and telecommunications’- and others for the essential part - made up only about 20% of outstanding credit.

Some segments of non-essential businesses are massively impacted. These include retail with outstanding loans of 9.52 lakh crore, tourism, hotels, restaurants and recreation services with loans of .92 lakh crore, construction with loans of Rs. 7.40 lakh crore and textiles with loans of 2.37 lakh crore. Other groups are also affected to varying degrees.  

Banks’ outstanding credit to non-farm businesses is about Rs. 55 lakh crores with about Rs. 10 lakh crores of loans being non-performing. As approximately 80% of the business credit outstanding is to non-essential industry groups, it would not be surprising if there are additional delinquencies of over Rs. 10 lakh crores during 2020-21.

Banks are indeed staring at massive spike in their non-performing loans.

Pushing the Can Down the Road?

Many businesses of ‘non-essential’ category have suffered a body blow on account of susceptibility to covid-19 risk and economic lockdown in operation for a month now. Some of these loans e.g. loans to tourism, hotels, restaurants and recreation service businesses will definitely become non-performing as their business itself would be lost or severely affected. Many others like textiles, organised retail etc. will become non-performing if these do not receive some grant support from the government and additional working capital support from banks.

RBI has allowed banks to grant a moratorium of three months on payment of all term loan instalments falling due and recovery of interest applied for cash credits during March 1, 2020 and May 31, 2020 (moratorium period). RBI has further permitted the banks to exclude this period to determine classification of assets in special mention/non-performing assets.

Finance Minister announced raising of threshold of default under the Indian Bankruptcy Code (IBC) to Rs. 1 crore from Rs. 1 lakh to exclude most MSMEs from the IBC and, if needed, to suspend certain provisions of the IBC Act ‘to stop companies at large from being forced into insolvency proceedings’ on account of disruption caused by covid-19.

SEBI has also asked rating agencies to keep off for the time being.

The measures taken by the Government and RBI will provide much needed breathing space to fundamentally strong businesses which are temporarily buffeted by the turbulence caused by covid-19 and the economic lockdown. These measures will, however, provide only a façade of solvency to businesses which are fatally wounded in this turmoil.

The banks are granting moratorium to all credits irrespective of the nature of impact on their businesses and credit quality. Moratorium is also being allowed to the mortally wounded businesses as well. For such businesses, the moratorium granted by the RBI and insolvency process suspended by the Government will only amount to keeping the show go on for some time.

The reality is indeed grim. RBI is aware of it. The banks have been asked to keep aside 10% of the gross amounts of such loans under moratorium as provisions.

The can has been pushed down the road for the present.

Returning Liquidity to RBI Instead of Providing Credit to Businesses

Demand for additional credit is on hold for the present. It will appear very aggressively very soon when the businesses are allowed to operate. Various business associations, especially those of MSMEs, have started asking for large additional credit demand in addition to generous fiscal packages.

There is no evidence of growth of depositors’ savings with banks slowing down so far. Deposits will also get impacted in times to come. However, RBI has started taking pro-active steps to provide additional lending resources to the banks and nudge them to lend.

First, Cash Reserve Ratio (CRR) has been reduced by 1% to place additional 1.37 lakh crore in the hands of banks to lend.

Second, RBI initiated two sets of Targeted Long-Term Repos Operations (TLTROs) of Rs. 1 lakh crore and Rs. .5 lakh crore providing money at Repo rate of 4.4% for three years for investing in investment grade corporate bonds, CPs etc. The first facility mandates 50% of the amount taken in TLTROs to be invested in securities of mutual funds and non-banking finance companies. The second facility reserves 50% for the smaller SMEs.

Third, the reverse repo rate, at which the banks keep excess money with RBI, has been reduced to very low level of 3.75% to nudge the banks to lend instead of parking funds with RBI.

RBI has conducted four TLTROs so far aggregating to Rs. 1 lakh crore. Along with CRR reduction, the banks have got about Rs. 2.4 lakh crore of additional funds for deployment. Where have the banks deployed this additional liquidity? Has credit moved?

Banks’ extra deposits (other than required under CRR) with RBI grew to Rs. 7.46 lakh crore on 10^th April, 2020 compared to Rs. 1.7 lakh crore on 22^nd March, 2019. Banks discretionary deposits with RBI grew by additional Rs. 5.76 lakh crore. In effect, the banks returned more than two and a half times of liquidity provided to RBI.

So far, banks don’t seem to have been nudged into lending. Let us see whether the penny will drop when the lockdown gets lifted.

Why Are Banks Reluctant to Lend to Businesses?

Lending to businesses involve risk- the business may not succeed or the businessman might commit fraud. In terms of risk perspective, the businesses, other than agriculture, are of three broad types. Conventional goods and service businesses, infrastructure businesses and start-ups.

Banks have been traditionally providers of working capital only to businesses. Equity and long-term debt were provided by developmental finance institutions or raised from the markets. Working capital loans did not involve taking a call on the basic soundness and profitability of businesses. It was more of cash-flows based lending. Working capital loans are less likely to turn non-performing.

After the economic liberalisation in 1990s and coinciding with phase-out of development finance institutions, the banks started financing term loans for longer period. For the infrastructure projects, even with repayment cycles of 15-25 years. Banks did not have experience and skills to assess the viability of such long-term project financing. Result, banks experienced large bouts of non-performing loans in 1990s and most prominently in last ten years.

Public sector banks were the least experienced in providing such infrastructure and industrial lending and they suffered the most. Their non-performing loans rose to 10-20%. While large injection of capitalisation by the government became necessary for PSBs, numerous cases of frauds have made public sector bank executives get entangled in criminal cases. Widespread risk averseness has been the natural outcome.

Banks do not understand business model of start-ups. They don’t lend to them. Banks have found infrastructure businesses- power, steel, roads, telecom etc. to be full of bad loans. They have stopped lending to them. The covid-19 has made even mature and established goods and services businesses unsettled and turn risky.

PSBs have more than two thirds of the business loan portfolio of banks. PSBs executives have suffered the most in the wake of non-performing loans. This explains their reluctance. They, incidentally, don’t suffer any adverse consequences if they do not lend. Greater safety increases risk-averseness.

It is not unnatural to expect that the banks will be excessively reluctant to lend to even mature and established businesses. I don’t expect the banks to ramp up lending to businesses in the face of extra demands for loans to survive, repair and re-construct their covid-19 battered businesses.

Should RBI Get into Lending to Businesses?

RBI had stopped discounting of bills of businesses in 1950s and 1960s. RBI used to provide refinance to development banks like NABARD, IDBI, ICICI, NHB and a few others. This was also stopped by the turn of millennium. Assets side of RBI Balance Sheet has no business or refinance loan asset. It only has government securities, gold and whole lot of foreign investment.

On 10^th of April, 2020, RBI had total assets of Rs. 50.76 lakh crore. Of this, foreign currency assets constituted as much as Rs. 33.86 lakh crore or 66.70%. Credit to central government (securities and ways and means put together) were Rs. 11.7 lakh crore or 23.04%. Gold (value Rs. 2.38 lakh crore) made up 4.69%. Remaining balance on the assets side was also made up essentially of some banks taking money from the RBI on repo window, which was neutralised by reverse repo deposits in liabilities side.

Central Banks in advanced economies provide refinance facilities to financial intermediaries and also buys corporate bonds and mortgage backed securities. This makes the central bank provide credit directly to businesses. This also increases supply of money and credit in the economy.

In India, the banks are reluctant to lend to businesses. They prefer to invest their lendable funds either in government securities or park with the RBI. If the bank channel is not operating, is it time for RBI to assume some credit risk and provide credit to businesses?

Extraordinary times call for newer solutions. It is unrealistic to reform the banking industry in shorter time. In fact, most of the efforts done in reforming the PSBs, like consolidation of banks and recapitalisation, have not done anything to turn the bankers into better risk-assessors and better lenders.

Much of the Targeted Long-Term Repos Operations (TLTRO) can be much better done directly by RBI, instead of doing it in a roundabout way of going through the banks.

For the present, instead of moving credit to businesses, RBI is facing the situation of banks parking with RBI more than double the liquidity provided to banks by the RBI. Situation seems to be getting desperate as the RBI is now thinking of using the Standing Deposit Facility (SDF) created by amending the RBI Act in 2018 to absorb excessive liquidity with the banks. SDF does away with the need for the RBI to hold government securities to repo when banks deposits in reverse repo. SDF is a clean deposit facility, more like a term deposit facility for banks with RBI.

Situation demands for RBI to start buying investment grade corporate bonds and mortgage backed securities. Going by the preference indicated by the measures taken so far and general reluctance to assume any credit risk makes one believe that this experiment will have to wait for some other time.  

CONCLUSION

Final users- governments, businesses and households- in India owes about Rs. 300 lakh crore or approximately $4 trillion, which makes up 150% of our estimated GDP of Rs. 200 lakh crores.

Banks are the principal providers of credit. Banks, including RBI have about half of the total outstanding credit i.e. about Rs. 150 lakh crores.

Total outstanding credit provided by the banks directly to businesses, government and households was about Rs. 130 lakh crores - credit to businesses of about Rs. 68 lakh crores, to governments of about Rs. 37 lakh crore and to households of about Rs. 25 lakh crores.

Principal reason for inability of the government to announce any survival and revival package, even for MSMEs, is the unavailability of business, value-added, number of labours employed, loss of output and profit data. There is an urgent need to establish the system of unique business ID and link significant business data with this.

Covid-19 and the economic lockdown ordered by the government to save lives has jolted the business loans portfolio of banks. Many businesses in travel, tourism, hospitality, construction, transportation, retail, entertainment, sports will fail. This can double their non-performing loans as a number of shuttered businesses and disrupted businesses will fail and suffer profitability shocks.

A good chunk of banks credit to businesses- over 15% i.e. over Rs. 10 lakh crore- is non-performing. Banks also have about 3% of their business loan portfolio stigmatised as frauds. It would not be surprising to see additional delinquencies of over Rs. 10 lakh crores.

RBI has allowed the banks to grant moratorium to all, including to the mortally wounded businesses. This will keep the show to go on for some time. The reality is, however, grim. The RBI is aware of it. The banks have been asked to keep aside 10% of the gross amounts of such loans under moratorium as provisions. For the present, the can has been pushed down the road.

RBI has provided additional liquidity to banks and reduced the reverse repo rate substantially expecting the banks to lend to businesses. Unfortunately, banks have acted in reverse by placing additional Rs. 5.76 lakh crores in deposits with RBI, effectively returning more than two and a half times of liquidity provided. So far, banks don’t seem to have been nudged into lending. Let us see whether the penny will drop when the lockdown gets lifted.

There are several reasons for banks’ reluctance to lend to businesses. They have not been lending to infrastructure for some time having suffered lot of delinquencies. Banks don’t understand start up businesses. The covid-29 crisis will make banks reluctant to lend to even mature and established businesses. In this atmosphere of excessive risk averseness, the banks are unlikely to ramp up lending to businesses in the face of extra demands for loans to survive, repair and re-construct their covid-19 battered businesses.

It is unrealistic to reform the banking industry in such troubled times. In fact, most of the efforts done in reforming the PSBs, like consolidation of banks and recapitalisation, have not done anything to turn the bankers into better risk-assessors and better lenders.

For the present, instead of being able to nudge credit to businesses, RBI is facing the liquidity rushing back to it. RBI is being forced to think of using the Standing Deposit Facility (SDF) to absorb excessive liquidity with the banks.

Extraordinary times call for newer solutions. It is time for RBI to think of providing credit to investment grade businesses directly. RBI can start buying investment grade corporate bonds and mortgage backed securities. Much of the Targeted Long-Term Repos Operations (TLTRO) can be much better done directly by RBI, instead of doing it in a roundabout way of going through the banks. However, going by the preference indicated by the measures taken so far and general reluctance to assume any credit risk suggest that this experiment will have to wait for some other time.  

SUBHASH CHANDRA GARG

NEW DELHI 23/04/2020