Is lazy banking here again?

Is lazy banking here again?

There is no shortage of noisy demands for banks to lend liberally to companies. But Indian banks seem to prefer to use their money to buy government securities rather than loan it to the private sector.

The daily Mark to Market column published in this newspaper pointed out on Tuesday that bank credit data for November shows a possible return to what was condemned as lazy banking earlier in this decade, when banks played safe and preferred to lend to the government rather than to more risky companies and consumers.

The return to lazy banking will pose several challenges to the Reserve Bank of India (RBI), as it tries to increase the flow of credit in the economy. Central banks adjust nominal short-term interest rates in the hope that they will affect the longer-term rates at which companies and consumers borrow. Central banks can also tinker with the ability of banks to create credit. This is the credit channel through which any central bank controls real economic activity (the other major channels of the so-called “monetary transmission mechanism" are interest rates, exchange rates and prices of assets).

The credit channel has been clogged the world over, making interest rate reductions less effective than before. That is one reason why some central banks, such as the US Federal Reserve, have decided to bypass the banking system and lend directly to companies in the commercial paper market and to homebuyers through the mortgage finance market.

India has not yet reached such a state of banking inertia. Annualized credit growth here is still at a healthy 29%, as Indian companies seek domestic finance rather than overseas loans and bonds. But the early signs of a return to lazy banking could ensure that RBI’s move to ease interest rates and credit flows may not be as effective as the central bank hopes.

There is another problem as well. Many seek a cut in the statutory liquidity ratio (SLR), or the amount of money that banks have to compulsorily invest in government bonds. A lower ratio should leave banks with more money to lend to the private sector. But the November credit data is an early indication that an SLR cut may be an exercise in futility.

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