Indian banks won’t lower their guard amid Covid-19 despite the central bank’s insistence

A rate cut diet.
A rate cut diet.
Image: REUTERS/Danish Siddiqui
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In a surprising move last Friday (May 22), India’s central bank announced yet another steep cut in repo rate. This is the second reduction in the rate at which banks borrow money from the Reserve Bank of India (RBI) since the spread of Covid-19 started hurting the country’s businesses and economy in March.

Now, the repo rate stands at an all-time low of 4% (pdf).

The intention of these cuts is to make borrowing cheaper for banks so they would dole out more loans to companies, which could potentially give India’s shrinking economy a much-needed jumpstart.

But if the past trend is anything to go by, these rate cuts would hardly achieve the desired outcome, economists believe.

“When a heightened level of risk aversion exists among banks, lower cost of capital alone incrementally will not translate into higher lending in the current situation,” said Sreejith Balasubramanian, economist at Mumbai-based mutual fund IDFC AMC. “Banks make lending decisions based on their risk appraisal and appetite which is currently low.”

The rate-risk conundrum

Even before the coronavirus-led lockdown pushed India’s slowing economy into a deeper quagmire, the RBI was on a rate-cutting spree. Between April 2019 and February 2020, the repo rate was reduced by 85 basis points (bps) to 5.15%.

But these steep reductions hardly yielded the desired results. Instead of banks giving out more loans than before, the credit growth in the country fell from 6.9% in April 2019 to a meager 1.4% in March this year.

“The sharp decline in incremental credit during the financial year 2020 was driven by slowing economic growth as well as heightened risk aversion among lenders,” says Karthik Srinivasan, group head, financial sector ratings, ICRA. The incremental credit growth from banks stood at $79.33 billion in the financial year 2020 as compared with $158.67 billion in the previous year, according to ICRA.


A major reason for the banks’ low-risk appetite is their massive pile of bad loans.

The gross non-performing assets (NPAs or bad loans) of Indian banks have risen from Rs3.12 lakh ($41.6 billion) crore in March 2015 to Rs9.40 lakh crore as of September 2019. Some of India’s largest banks, including government-owned State Bank of India, and private lenders ICICI Bank and Axis Banks, are all reeling under massive corporate defaults.

“Banks have been facing NPA problems and hence they prefer to lend only to certain sectors or companies,” said Kavita Chacko, senior economist, CARE Ratings.

In fact, banks are so spooked that they are opting to park their surplus money with the RBI, even when they don’t need to.

No parking here

Besides making it cheaper for banks to borrow, the RBI has also taken steps to discourage them from parking surplus money with it.

So, between April 2019 and February this year, the reverse repo rate, at which banks lend to the RBI, was slashed by 85 bps. It was further cut by 155 bps to a historic low of 3.35% after the Covid-19 outbreak began crippling the economy.

But this too hasn’t incentivised the banks to lend.

There has been a staggering increase in the money that banks have been parking with the RBI since April last year, showing that banks favour RBI’s low-interest-rate deposit rather than lending the money, which could give them higher returns.

In fact, this trend has escalated after the RBI announced the Covid-19 stimulus.

On April 30 last year, banks had deposited Rs11,488 crore surplus cash with the RBI under the reverse repo window. In contrast, on Feb. 28, they kept Rs2.93 lakh crore with the RBI. And the deposits sharply rose post Covid-19 outbreak with Rs7.17 lakh crore being deposited with the central bank on May 21.

This trend is unlikely to reverse, analysts said.

Revival still uncertain

The economic slump and lockdown due to Covid-19 are likely to spook banks further and discourage them from lending. “Now they (banks) will be even more vigilant while lending due to economic uncertainty,” warns Chacko of CARE Ratings.

In addition, companies may also hesitate in making any capital-intensive plans for now, which means loan demand will remain subdued. “Today with the lockdowns in place there is a near absence of economic activity and going forward too the business scenario is very uncertain so many businesses would not like to add to their liabilities,” says Chacko.

However, there might be a silver lining.

Given that most companies in India did not make much money in the last couple of months—and many remained completely shut—due to the nationwide lockdown, there may be demand for short-term loans to meet operational expenses.

The government is certainly trying to push banks to lend more. As a part of the $266 billion coronavirus-relief package, the Narendra Modi government is offering a credit guarantee to lenders. This means the government will repay the debt if small and mid-sized businesses’ default. “So, while rate cuts might help on the margin, more definitive measures to reduce this credit risk and provide better clarity on the government’s increased borrowing plan would greatly help,” said Balasubramanian.

Chacko also said that the banks will draw some comfort from the government’s credit guarantee scheme but it remains to be seen how much risk they are willing to take by lending in the current scenario. “Here too, banks would still prefer to lend to bigger and financially sound businesses,” estimates Chacko.