In the fiscal year gone by, the Indian banking system managed to raise its game to meet the funding requirements of the economy, after being dethroned as the primary source of money in the year before.

Banks were no longer the preferred lenders in FY17, with their share dropping to 34% in the total flow of funds to the commercial sector.

The reason was that the bond market had suddenly turned friendly through a sharp fall in yields, and non-banking entities were hawking their loans aggressively. Besides, some companies realized that the otherwise expensive dollar funding route was looking cheap, too.

On the other hand, banks had become an unfortunate warehouse of defaulted loans that shackled their lending and kept interest rates high.

But all that seems to have changed with the banking system recovering in the following fiscal year. Indian banks lent half of the money required by companies in FY18, while the other half was met by non-banking financial companies, and the bond market.

What made this happen was the Reserve Bank of India’s efforts to neutralize the abundant liquidity that made bond yields rise sharply. Having lost the cost advantage versus bank loans, borrowers realized that banks were willing to give cheaper credit.

The key question: Can banks hold on to the crown of being preferred lenders?

The first four months of the current fiscal year (FY19) show that the crown is slipping. Banks have lent only 3% of the incremental funds during this period, while 65% has come from non-banking sources, such as mutual funds and Life Insurance Corporation of India. But it would be too early to judge as the busy credit season is yet to arrive.

Nevertheless, the banking sector is far from being ready to meet the economy’s funding needs. Public sector banks that give 70% of the sector’s loans are stymied in their efforts to do so, as half of them are under prompt corrective action. They still warehouse a large amount of bad loans and this pile is not reducing any time soon.

The efforts of bankers are still focused on resolution of the toxic loans rather than lending to new businesses.

Private sector banks will carry the baton of funding, but on an aggregate basis, banking could find it difficult to be the lead financier of the economy.