Home / Opinion / Views /  Opinion | When credit risk gets shuffled around India

The world of finance is full of misplaced priorities and ironies. Everything is supposed to be finely calculated, even small sums at little risk, but crises still strike every now and then. Almost all of them are traceable to debt. During the West’s Great Recession a decade ago, India prided itself on its macro-prudential foresight and even set up the Financial Stability and Development Council (FSDC) of various regulators to watch system-wide dangers. But, as it turns out, overall systemic safety is very hard to assess. According to the recent Financial Stability Report issued by the Reserve Bank of India, the banking sector’s bad loans look set to start dipping at last, with its proportion of gross non-performing assets projected to fall from 9.3% of advances as of 31 March 2019 to 9% by the end of the current fiscal year. If it’s a relief that bank asset quality is finally on the recovery path, it’s welcome that the Securities and Exchange Board of India has taken action to stop mutual funds from endangering investor money by lending it out recklessly. In all this, credit at higher echelons of the economy has tightened. At lower levels, however, there are signs of a loan glut ahead.

Take the recent U.K. Sinha Committee recommendations for medium, small and micro enterprises in the country. To aid a sector that’s estimated to employ 110 million people, among other things, the panel has proposed extra credit allocations for these businesses. For collateral-free loans extended to small businesses, self-help groups and other such borrowers who qualify for credit under the government’s Mudra scheme, it proposes that the cap on advances be doubled to 20 lakh. This would address capital starvation among lower-rung entrepreneurs and aid the effort to democratize startups in India, no matter how modest the venture. It bodes well for the “ease of doing business" on the ground. Less re- assuring, though, is the phenomenon of these loans going bad. Some reports suggest that about a tenth of all Mudra advances are now impaired, possibly more. Given the social aspects of the scheme, one cannot expect its creditworthiness checks to be very stringent, but still, asset quality is important for banks.

So far, regulatory attention has focused on higher-end debt. This is natural, given the risk of high-profile defaults having serious knock-on effects, a risk all too visible in recent times. Since 2016, while bankruptcy fears have pushed corporate India to reduce debt levels, shadow banks have used an enlarged share of national savings to create far riskier assets. Some of the worst deals were done either in bad faith or in a race for higher yields on debt. Curbs have now been placed on the most dubious of these practices, and in a way that would let the government claim a larger chunk of the money available for lending. Credit available for private companies may suffer, but this ought to spell greater systemic safety as well. Yet, while better discipline at the upper reaches of the economy would be good, trends point to default risks getting shunted downwards—to the Mudra zone. Debtors here have far fewer interlinkages, so contagion is no big worry. However, state- directed loans for the less privileged turning bad could foreseeably cause a lower-order crisis that would keep the general cost of capital higher than it should be. The FSDC needs to stay vigilant on this front too.

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