Diversified credit growth lowers concentration of risk for banks

The Reserve Bank of India (RBI), notwithstanding concerns over accelerated pace of growth in retail credit, has said the credit growth has been broad-based making banks less vulnerable to credit concentration risk.

"Diversification of credit base with increased focus on retail loans, which generally have low delinquency rates, has also contributed to the more favourable credit risk profile," RBI said in an analysis of credit growth in the Report on Trend and Progress of Banking in India, 2005-06.

RBI said the high growth in credit offtake in 2005-06 was more broad-based than in the previous two years. Retail loans, which witnessed a growth of over 40 per cent in 2004-05 and again in 2005-06, have been the prime driver of credit growth in the recent years.

Retail loans as a percentage of gross advances increased to 25.5 per cent in March 2006 from 22 per cent in March 2004.

In the first three months of 2006-07, retail credit has grown by 47.2 per cent over a year earlier with housing loans increasing by 54.3 per cent. Loans to commercial real estate grew by 102 per cent, credit to industry by 27 per cent and loans to agriculture by 37 per cent.

In bank-based financial systems such as India, bank credit plays a critical role in facilitating the growth process and hence credit booms are often positively correlated with a high growthphase of the economy.

Credit booms are often followed by dilution of risk assessment criteria by banks and financial institutions, which may trigger episodes of financial instability.

In this regard, financial instability that might result from credit booms, can, in fact, threaten price stability. Therefore, credit booms need to be carefully monitored by policy makers, RBI noted.