The Reserve Bank of India has taken ample steps to increase the quantity of money flowing through the system. Banks have been provided with enough bait, but they aren’t biting. So what does the government do? It holds a gun to their head.
Consider the latest round of monetary moves. After slashing the repo and reverse repo rates on Friday, the government directed public sector banks to lend Rs56,000 crore more than usual in the next three months. A government press release on Friday stressed that New Delhi would “closely monitor” bank credit, announcing “special monthly meetings of State Level Bankers’ Committees” to oversee lending practices.
The government is clearly concerned that banks aren’t lending. But we’re not sure they can do anything, besides ensuring the presence of liquidity. It’s finally up to individual banks, not bureaucrats in New Delhi, to assess risks and then disburse loans. Forcing a bank manager to lend money to undeserving companies will only lead to non-performing assets on the balance sheet. India already saw that in the 1980s when banks teetered on insolvency thanks to government pressure to extend credit.
There is an unintended consequence here worth noting. As rates go down, the price of government bonds shoot up; if banks believe rates will continue to decrease (as they have consistently since October) and consequently prices increase, they would want to buy as many bonds to be able to sell at higher prices in the future. And in such bad times, a loose monetary policy may well lead banks to invest in government assets, and not the industries that suddenly find themselves cash-strapped. That’s what happened during the previous slowdown earlier this decade.
So how can credit be provided? Monetarily, the government has done all that is possible. Banks will only begin to lend robustly when the overall financial situation improves. That’s where the fiscal side comes in. There’s enough room for liberalization in, say, the insurance and banking sectors. If the government is interested in sending the right signals to the economy, it should invest in pushing through reform, not pushing through bad loans.
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