Talking Point. Can the economy afford lazy banking?

Even as economists and market players try to make sense of India’s GDP numbers that continue to show a healthy 7-8 per cent growth in our economy, bank credit, considered a proxy to the state of the underlying economy, has a different story to tell.

Over the past three years, the link between credit growth and GDP has been weakening, so much so that it is now difficult to connect the two. Weak bank balance sheets and over-leveraged corporates have caused credit growth to slip to 5-odd per cent levels. Lending to corporates, in particular, has taken a beating, with bank credit within this segment contracting over the past year.

But that’s not to say that corporates have not been raising money to run their businesses. High-rated corporates have been flocking to the bond market to raise funds. What’s more, while the RBI has been crying itself hoarse on how banks have been tardy in passing on its rate actions, transmission in the bond market has been quick and smooth.

If cheap borrowing cost has been a big draw for corporates, banks too have found a way to get a piece of the action. While banks have been staying clear of lending to corporates directly, they have found a less risky and more viable way to fund them by lapping up corporate bonds.

When SBI, India’s largest lender, declared its latest June quarter results, the market was disappointed. A sharp rise in slippages aside, the bank’s weak core performance has been a cause for concern. The muted 1 per cent growth in advances that SBI reported for the June quarter is way lower than the growth at the system level.

But there is another, somewhat discreet trend that is emerging within SBI’s loan portfolio. While the bank has been shying away from lending to corporates —large, mid-sized companies and SMEs together witnessed a 4 per cent decline in credit growth — it has been deploying more funds towards corporate bonds. Around ₹40,000 crore of corporate loans have moved to bonds over the past year.

According to data from the Securities and Exchange Board of India (SEBI), private placement of corporate bonds rose by 40 per cent in 2016-17 even as bank credit to the corporates has been shrinking.

Given the lag and inefficiencies in the transmission of RBI’s rate action by banks, corporates —the high-rated ones — have preferred to raise funds from the bond market, which are cheaper by 40-50 basis points.

Corporates are able to lock into low rates (fixed) for three to five years, as against bank lending rates that are variable and can inch up in the next two to three years.

Banks too stand to gain. One, they get to pick and choose highly rated corporate bonds to deploy their funds, thus mitigating their risk. The lower yields that they earn by investing in such bonds (vis-à-vis lending directly to corporates) is also limited to such bonds and does not impact their legacy loans.

If banks were to pass on the rate benefit (say, the 40-50 basis points lower rates in bond markets) in its entirety by lowering their benchmark MCLR or base rate, it would impact their entire loan book and add pressure to their margins.

There is yet another inconspicuous advantage to banks. All banks are required to lend a minimum of 40 per cent of their total loans to the priority sector. Funds deployed to corporate bonds do not form part of banks’ loans while computing priority sector lending (PSL) target. Hence, banks’ PSL mandate, to that extent, is lower.

While banks have a lot to gain by shifting away from direct lending now, excessive exposure to corporate bonds can hurt, if rates start to move up. Banks are required to mark-to-market such investments, which can lead to losses if yields start to move up.

Banks, flush with liquidity, are also sitting on a large portfolio of government bonds — deploying 7-10 percentage points more than that mandated unde SLR requirement. These investments can also lead to treasury losses, when rates start to move up.

With bad loans still on the rise, banks have understandably been chasing safer avenues for deploying funds. But that fails to serve the needs of the economy at large.

It is true that alternate funding sources have been growing their share in the overall credit to the economy. NBFCs have been growing their loan book at a healthy 17-20 per cent over the past couple of years. But these channels are still not significant enough to serve the needs of corporates at large.

Given that the Indian bond market still has a fairly narrow composition consisting mainly of higher-rated bonds, its share in the overall credit in the system is still small.

With bank balance sheets still on the mend, how long can the economy afford lenders resorting to lazy banking?

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