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Posted by: Deepa Vasudevan on Wed, Oct 8th, 2014

The Much Discussed Slowdown in Bank Credit

For the fortnight ending September 19, 2014, bank credit grew at merely 9.7% y-o-y. That is the lowest rate of credit growth since June 2001 (Pic 1). The decline started about a year ago; but the steep fall in August/ September has led to considerable discussion in the press.

 

Pic 1: Growth in Bank Credit and Aggregate Deposits (% y-o-y)

 

Growth in Bank Credit and Aggregate Deposits (% y-o-y)

Source: RBI Weekly Statistical Supplement

 

This situation is a complete turnaround from the last two years, when there were concerns that deposits were growing much slower than credit (in the picture above, the blue line showing deposit growth is below the black line showing credit growth until end of 2013). In 2014, deposit growth has stabilized, but bank lending has plunged, leading to concerns that the much awaited industrial revival may not be happening after all.

 

Why is bank credit growth falling? There are two schools of thought. The first argues that corporates prefer to source funds through cheaper commercial paper or overseas loans because interest rates on bank loans are too high. The implication is that bank lending will pick up once rates are reduced. An alternate view, endorsed by RBI, is that a combination of factors are at work:  the statistical impact of a high base effect (in Aug- Sept 2013 bank credit rose by an unusual 17%); the shift of corporate borrowing to lower priced non-bank funds; and the reduction in bank balance sheets due to the sale of distressed loans to asset reconstruction companies.  It is implied that these factors are temporary, and demand for bank loans will go up automatically with a pickup in investment.

 

Which of the two views fit our macro economic situation better? History provides some clues. If we compare annual growth in bank credit since 2000-01 with real economic growth, it is obvious that higher economic growth has pulled up bank credit and not the other way round (Pic 2). In fact, an RBI study has concluded that in the non-agricultural sector, bank credit is primarily driven by output[1].

 

Pic 2: Bank Credit and Economic Growth (% y-o-y)

Bank Credit and Economic Growth (% y-o-y)

Source: RBI Handbook of Statistics of the Indian Economy

 

Clearly, ensuring a pro-growth environment is necessary to stimulate bank lending. Reducing rates may be one of the reforms needed to restore investment, but it is not the only, or even the most important one. 



[1]“ Credit and Growth Cycles in India: An Empirical Assessment of the Lead and Lag Behaviour”, Krittika Banerjee  RBI Working Paper Series WPS (DEPR):22/2011, December 2011

prakash on Mon, Oct 13th, 2014 10:50:22 am

There seems to be +ve correlation between GDP and credit growth but not so between deposit and credit growth.Needs further analysis!

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