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Mumbai: Banks in India may see a significant drop in the rate of growth of the loans they extend to companies and individuals because they don’t have money to do so despite the central bank’s efforts to infuse liquidity into the system, say some economists and equity analysts.

They also warn of defaults by some companies, especially the so-called small and medium enterprises (SMEs) that borrowed in better times.

The prognosis comes at a time when Indian companies are already finding it difficult to borrow money from banks although some equity analysts say that the slowing growth in loans is a result of lower borrowing needs of companies brought about by slowing growth in their profits.

Also See Liquidity Trap (PDF)

Total credit growth for Indian banks on 10 October, on a year-on-year basis, stood at 29.4%, according to the Reserve Bank of India (RBI), higher than the central bank’s desired growth. The gross credit extended by Indian banks is about Rs26 trillion.

“The 29% credit growth was very high; going forward, this is set to go down sharply," said Sharmila Whelan, India economist at the Hong Kong office of foreign brokerage CLSA Asia Pacific Markets, in a telephone interview.

According to her, there could also be “a rise in corporate loan defaults in India and other parts of Asia".

Indian companies are better placed to service debt compared with their peers in other regions, said Janmejaya Sinha, managing director of the Boston Consulting Group in India, who added that SMEs remain highly vulnerable.

“Some of these SMEs could go bankrupt," he said. Most SMEs in India take loans at higher rates of interest than large companies, and with their revenue falling as a result of the economic slowdown, their ability to service debt has been compromised.

Long wait: Customers at an ICICI Bank branch in Mumbai. Lending by Indian banks may slow due to a pronounced asset-liability mismatch. Bloomberg

State Bank of India (SBI), the country’s largest bank by assets, however, isn’t worried. On the sidelines of a Mumbai conference on Thursday, organized by industry lobby Federation of Indian Chambers of Commerce and Industry and industry body Indian Banks’ Association, O.P. Bhatt, chairman of SBI, was reported by PTI as saying credit growth was likely to continue to grow at 29% in 2008-09. “There is a huge demand for credit from the corporate sector as global funding sources have almost dried up. Most corporates have turned to banks for adequate credit," he said.

Following a global credit crunch, central banks across the world cut interest rates, assured credit lines for local banks, and initiated billions of dollars of currency swap lines to keep the system liquid.

RBI has cut its key policy rate by 150 basis points in two stages, the cash reserve ratio (CRR) that determines the amount deposited by lenders with the central bank by 350 basis points, and the statutory liquidity ratio (SLR), or the portion of deposits banks have to invest in government bonds by 100 basis points. One basis point is one-hundredth of a percentage point.

While these measures by the central bank helped reduce local inter-bank lending rates, which at one point had shot up to at least 21%, companies continued to find it difficult to raise money from reluctant lenders, who demanded high interest rates.

Many Indian companies had picked up cheaper foreign currency debt in the past few years, especially from London. But while the global credit freeze is showing signs of easing, overseas borrowing rates remain high and it is unlikely foreign lenders will lend to Indian companies in the current economic environment.

“It will be hard to replace foreign loans with foreign loans," said Manisha Girotra, chairperson and managing director of Swiss bank UBS AG’s Indian arm. Locally, banks will limit credit to large companies, she added. That could hurt many small and mid-sized firms, which are looking to substitute large foreign debt with domestic capital.

After meeting with finance minister P. Chidambaram on 4 November, India’s state-owned banks decided to slash their prime lending rate (PLR), or the rate at which they lend to their most creditworthy customers, by up to 75 basis points to between 13.25% and 13.5%. Foreign lender Citibank India also decided to cut PLR by 50 basis points to 15%.

The government also unveiled measures to help banks reduce bad loans and continue lending to SMEs, including doubling the credit guarantee, or the facility to borrow without collateral, for SMEs from Rs50 lakh to Rs1 crore.

Asset-liability mismatch

The impending slowdown in credit growth that experts warn of has its roots in the asset-liability mismatch in the banks’ balance sheets.

“The likely outcome (of this mismatch) is a pronounced slowdown in lending," said Saurabh Mukherjea, head of Indian equities at UK-based equity research house Noble Group. According to him, “this lending slowdown is almost certainly likely to coincide with rising non-performing assets (or bad loans)".

This mismatch has been driven by two key factors—growing dependence on short-term liabilities and credit growth running ahead of deposit growth.

Over the past three years, said Mukherjea, Indian banks had funded long-term credit using short-term liabilities, with the phenomenon becoming more pronounced in 2007-08, as bankers, expecting interest rates to moderate, took on increasingly shorter duration liabilities.

These banks are now left holding a large volume of liabilities that are maturing faster than assets. Given the liquidity squeeze, replacing these maturing liabilities will be an uphill task.

Deposits, the cheapest form of financing (liabilities) available for banks, have taken a backseat in the past three years, as “banks funded incremental credit disbursals by eating into their investment portfolio", said a recent Noble Group report.

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