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Bank lending: the wrong cure

Bank lending: the wrong cure
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First Published: Tue, Feb 17 2009. 11 17 PM IST

Illustration: Jayachandran / Mint
Illustration: Jayachandran / Mint
Updated: Tue, Feb 17 2009. 11 17 PM IST
All the exhortations of the government seem to have had little effect on bank lending so far. Reserve Bank of India data for January show that bank credit has been shrinking for two months in a row. These numbers will doubtless be seized upon by the government as a signal that bankers are not doing their bit in combating the slowdown.
The fact of the matter is that demand for funds has fallen. There’s plenty of anecdotal evidence that firms have been curtailing production and working for less than the full week. Many projects have been shelved. It’s rather obvious that, if industrial production in the country has been contracting, then so should loan demand from the manufacturing sector. On the retail banking front, real estate prices continue to be too high, with the result that people are not buying houses, clearly seen from the sharp drop in retail lending.
Illustration: Jayachandran / Mint
It’s also true that some banks have tightened lending standards. They have every reason to do so, as the bank results for the December quarter show that bad debts are rising in the system. Yet, their full extent has been camouflaged by more liberal classification norms for non-performing assets and the ability of banks to make larger loan loss provisions out of windfall treasury gains arising out of the steep fall in government bond yields in the last quarter. With yields hardening, that cushion will no longer be available to banks in the current quarter.
In fact, the reluctance of banks to lend has been a complaint by governments the world over, including in the US and the UK. The argument often made in the developed world is that if only the toxic assets are removed from bank balance sheets and they are adequately recapitalized, lending could begin anew.
That line of thinking ignores the fact that reining in loan growth in a worsening environment is merely prudent banking policy. Governments seem to have great difficulty in understanding that. Not surprisingly, Chinese banks have reported a doubling of loan growth in January compared with the year-ago period—loans made during the month amounted to as much as one-third of all loans made by banks last year. This kind of lending is almost certain to increase future bad debts.
In India, the problem is compounded by the fact that the government has very little leeway to spend directly. Its gargantuan borrowing programme has already led to higher bond yields. In the circumstances, it increasingly relies on state-owned banks to boost the economy by lending more and at low interest rates. The upshot will be worsening asset quality. The signs are that the current downturn is likely to inflict much pain on the economy. The government would do well not to compound the problem by weakening the banks.
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First Published: Tue, Feb 17 2009. 11 17 PM IST