Why banks aren't ready for economic heavy-lifting this time around

Outside the Eco-Chamber

On May 7, the banks deposited a total of Rs 8,19,783 crore with the Reserve Bank of India (RBI). Except for May 1, in the remaining days in May, the banks have deposited more than Rs 8 lakh crore with the RBI.

Banks deposit the excess money they have with the RBI through what is called the reverse repo window. The RBI pays them interest on these deposits. This rate of interest is referred to as the reverse repo rate, and it currently stands at 3.75%.

On February 20, banks had deposited just Rs 39,983 crore with the RBI under the reverse repo window. Clearly, in a period of a little over two and a half months since then, banks have ended up with more and more deposits, which they don’t want to lend, and are instead depositing with the RBI. In the second half of March, the banks deposited Rs 3.61 lakh crore every day on average. By the second week of April, this had jumped to Rs 7.24 lakh crore. In May, it has averaged Rs 8.28 lakh crore.

Why is this happening? With economic activity crashing, the government is trying to take on the load of the spender of last resort. It has deposited money into women’s Jan Dhan accounts. It has brought forward the payments made under the Pradhan Mantri Kisan Samman Nidhi (PM-KISAN) scheme. This money has been withdrawn, spent and found its way back into bank accounts. This is one of the reasons for the spurt in the money being deposited through the reverse repo window, though not the only reason for it.

In the normal scheme of things, banks would have lent out this money. But with the lockdown on, bank lending has collapsed.

Vehicle sales have crashed. This means, banks haven’t been able to give out vehicle loans. The same is the case with home loans, consumer durables loans and so on. Over and above this, with social distancing norms in place, even someone who wants a loan may not be able to go to a bank and get one.

Also, with most factories shut (now gradually opening up), businesses have been reluctant to borrow as well. Over and above this, many corporates are trying to use the current bleak scenario as an opportunity to get leaner and fitter. Given this, they clearly don’t have any appetite for bank loans. And finally, many corporates are already heavily leveraged.

The Indian economy had been slowing down even before Covid-19 struck. And the current state of bank lending reflects the state of the economy. Given that a large part of the economy is shut, it is not surprising that lending by banks has gone the same way and they are parking a greater amount of deposits with the RBI.

Also, banks are getting ready for the months to come, expecting a spurt in bad loans. Bad loans are largely loans on which repayments haven’t been made for a period of 90 days or more. Many businesses are likely to default in the months to come. Over and above this, as companies fire people, cut their salaries, freeze increments and postpone the joining dates of new hires, there is bound to be an increase in retail loan defaults as well. The current rate of default on retail loans is just 2%. But more people are likely to default on their home loans, vehicle loans, personal loans, consumer durable loans, credit card outstanding, etc.

The fact that private banks are preparing for this can be concluded from the fact that while overall recruitments are under freeze, they are looking to hire people in their recovery departments.

In this scenario, it is hardly surprising that banks aren’t willing to lend. One also needs to take into account the fact that banks, in particular public sector banks, are yet to come out of the mess they landed themselves in post-2011 onwards.

In the aftermath of the financial crisis of 2008, public sector banks were encouraged to carry out an easy lending policy. This was done to ensure that the economy continued to grow. This easy lending did help perk up growth for a couple of years, but after that many corporates who had taken loans started to default. The banking crisis started in 2011, but it was recognised only in late 2014 and early 2015. The total amount of bad loans of public sector banks as of December 31, 2019, stood at Rs 7,16,652 crore. This has come down from a peak of Rs 8,95,601 crore, but is still a high number.

Given this, it is hardly surprising, that the banks do not want to make the same mistake all over again. While the government may want the banks to do the heavy-lifting of getting the economy back on track, the fact of the matter is that the banks are clearly not in a position to do so. The banks clearly understand this. Which is why they are happy to deposit lakhs of crore of rupees with the RBI and earn a minuscule rate of interest of 3.75% on it, rather than lend that money out in the hope of earning a higher rate of interest. And that’s the long and short of it.