Banks flush with funds but reluctant to pursue aggressive lending

Loan growth for banks is yet to pick up despite a 100 bps cut in the policy repo rate by the Reserve Bank of India (RBI) since February

A few days back, a higher-rated PSU got a short term loan of ₹1,000 crore from a public sector lender at 6.10 per cent. While it is normal for better-rated entities to get a sweeter deal from lenders, this rate surprised many market observers as it would barely cover the bank’s cost of funds. 

The reason for short term rates to fall this low is the huge surplus liquidity in the banking system, that has averaged ₹3 trillion since the start of June, and even topped ₹4 trillion on some days. And this is expected to persist over the next few months as banks’ cash reserve ratio (CRR) requirements are also to be reduced by 100 basis points (bps) in phases, starting September. 

The CRR cuts would push liquidity levels to as high as ₹5 trillion by November-December, assuming neutral a impact from foreign exchange operations, reckoned Gaura Sen Gupta, chief economist at IDFC FIRST Bank. 

Meanwhile, a mid-sized public sector bank with lots of headroom to lend, decided not to extend a loan to a large NBFC with significant presence in the microfinance sector that is facing headwinds. Bank loans to NBFCs have contracted 0.3 per cent on a year on year basis till May, as compared to a 16 per cent growth recorded last year. 

In fact, banks’ overall loan growth is yet to pick up despite a 100 bps cut in the policy repo rate by the Reserve Bank of India (RBI) since February. Credit growth dropped to 9.6 per cent year on year till the fortnight ended June 13, as compared to 19.1 per cent a year back. Credit growth for industry has slowed sharply to 4.8 per cent from 9.4 per cent last year mainly due to a slump in credit flows to large industries.

 

The sluggish credit offtake trends have triggered alarm bells for the authorities, and the finance ministry, in a recent interaction with bank CEOs, has emphasised the need to lift loan growth to boost the overall momentum in the economy. 

These kind of financial conditions – benign interest rates, huge surplus liquidity – are not new to banks, but their last tryst with them doesn’t evoke fond memories.

 

After the 2008 global financial crisis, interest rates as well as cash reserves ratios were cut sharply. Even at that juncture, the North Block was keen to beef up bank credit to lift GDP growth.

 

However, the sharp uptick in credit growth in the early part of the last decade was followed by an equally significant spike in bad loans with the gross non-performing assets of banks hitting 11.6 per cent of gross advances by March 2018, before reversing course.

 

The question remains if banks will push loans amid a large liquidity surplus and downward trajectory of interest rates, this time around.  

 

Growth push

 

“Despite sizable monetary policy easing, non-food bank credit growth continues to slow,” Barclays said in a report. “While this can be attributed to the high base, the flow of bank credit has also declined materially vs the same period last year. The rising share of non-bank sources of funding could be a key reason for the shift away from bank credit,” the report added.

 

India’s GDP grew 6.5 per cent in FY25 – the slowest pace since the Covid-19 pandemic — and the RBI expects the same pace of growth in this financial year (2025-26) as well. While India remains one of the fastest growing large economies, the government and the central bank aspire for a higher growth trajectory. It is in this context that the government is prodding banks to step up loan growth. 

 

The central bank, while reducing interest rates sharply in a short span of time and maintaining surplus, has emphasised on the transmission of policy rate cuts to the lending and deposit rates. Typically, it takes two to three quarters for this transmission to play out, and the prospective CRR cut was aimed to speed up this relay.

 

 “The fact is that the cost of funds has not come down so far. Banks have started to re-price deposits but the effect will come with a lag. Net interest margins are going to be under pressure for at least the current financial year,” said a senior official from a large public sector bank, indicating a preference for bolstering the bottomline over chasing topline growth.

 

Following RBI’s 50 bps cut in the repo rate between February and April, banks have reduced the external benchmark-based lending rates by an equal magnitude. EBLR-linked loans constitute about 40 per cent of banks’ loan books.

 

RBI data showed the weighted average lending rate (WALR) on fresh and outstanding rupee loans of commercial banks declined by 6 bps and 17 bps, respectively, over the February-April period. However, on the deposit side, the weighted average domestic term deposit rates (WADTDRs) on fresh and outstanding deposits moderated by 27 bps and 1 bp, respectively, during the same period.

 

“Contrary to popular belief, lower interest rates do not always lead to increased lending,” Deep Narayan Mukherjee, Partner & Director at BCG, said in a report.

 

“While rates act as enablers, the actual expansion of credit hinges on borrower sentiment and lenders’ risk appetite. Credit demand follows the momentum in economic activity and often continues to rise despite a rate hike. The reverse is also empirically observed. If credit demand is moderate, a reduced interest rate may not boost it over the next 12-24 months,” the report said.

 

Once bitten, twice shy — India’s bankers are not likely to take the aggressive path to expand their loan book, in the fear that they could turn sour once the interest rate cycle turns. Moreover, they do not want investigative agencies rummaging through their premises after retirement – another trend that had dogged them in the last decade.