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5 Things to Know About Poor Bank Credit Growth
All seems to be going well for the economy. Macro-economic indicators signal a recovery in the offing. Industrial production is up; inflation is down, well, comparatively at least; deficits are narrowing; the rupee is more stable.
Before you start cheering, there is one indicator that is not showing good signs - bank credit growth.
Here are five things to know about the issue:
What is credit growth:
In exchange for the money you deposit in your bank account, banks promise to pay you a regular interest. The longer the tenure of your account, the higher is your interest rate. This is because, your deposits are a source of cheap funding for banks. It has to pay you only 4-6% on your savings account deposits. This is lower than the 8% it pays when borrowing from the RBI. Banks then lend the money for a higher interest rate. This earns banks an interest income. The higher interest payments help banks make profit. The rise in demand for loans is called credit growth. This is an important indicator of economic activity.
Why credit growth matters:
Companies borrow from banks when they start new projects. They are one of the biggest loan customers to banks, which make significant profits. After all, companies borrow amounts in crores - not like the lakhs we borrow. So, interest payments too run into crores of rupees. Loan demand is an important indicator of new projects, investments and corporate activity in the country.
What data suggests:
The RBI collects data from banks and non-banking financial companies (NBFCs) on credit demand on a monthly basis. Media reports suggest that credit growth fell to 9.68% in the fortnight ended on September 5. This is the first time in five years that credit growth has fallen below 10% levels. This is remarkable because India went through a bad phase of slow economic growth in the last five years. It, thus, shows that the Indian economy may not really be growing as much as the market is expecting.
Why credit growth slowed:
High interest rates are the biggest hurdle for a rise in loan demand, banks and analysts suggest. When companies borrow from banks, they have to pay regular interests to the bank. This eats into their profits. As interest rates rise, the cost of borrowing goes up. This discourages companies from borrowing more. Eventually, it affects growth. To spur loan demand, lenders have requested the Reserve Bank of India (RBI) to cut rates, a Business Standard report suggests. However, the RBI held rates steady in its recent monetary policy review on fears of a future rise in inflation due to the crisis in the Middle-East. The high base last year is also responsible for lower credit growth.
The new problem:
There is another - albeit surprising - offshoot of this problem. Banks now see higher growth in deposits than loans. As a result, they have more liquid money lying idle. Earlier, banks were severely cash crunched. Now, they have the exact opposite problem. If deposits grow at a faster rate than loans, banks may not have enough money to pay as interests. This affects profitability too. This is why the State Bank of India cut deposit rates in mid-September.
People may be cutting down their borrowings, but they are increasing their deposits. RBI data showed that deposits rose by 13.78% in the fortnight ended September 5, 2014. Non-food credit growth stood at 9.8% over the same period. This means banks are getting more deposits and lending less money. For the same period last year, credit growth was 17% while deposits grew 13%.