The Reserve Bank of India (RBI) has recently published a working paper pertaining to ‘Asset quality and credit channel of monetary policy transmission in India’. This work is part of the RBI Working Papers series that was launched in March 2011. The study underlines the efficiency of the credit channel of monetary policy transmission in India, which primarily functions through alterations in lending.
The functioning of the credit channel
The credit channel implements its tasks through two primary mechanisms. One is the bank lending channel where it influences the totality of bank lending. The other is the balance sheet channel, which has an impact on the allocation of loans.
The slowing down of credit growth
Since 2013, there has been a steady deceleration in credit growth in India. This phenomenon can be attributed to the issues related to asset quality stress in the banking system, a deceleration of economic activity, along with moderation in bank deposits. The growth rate in credit offtake showed a significant drop, reaching 5.8% in November 2020 from 14.2% in 2013. There is a noticeable disparity in credit growth between public and private sector banks.
Potential determinants of credit growth
Several factors influence the growth of credit. Here are some key potential determinants:
– Asset Quality Stress: In the early 2010s, a downward trend in the asset quality of Indian banks was observed, negatively impacting their profitability. Asset quality of Scheduled Commercial Banks (SCBs) is gauged as a ratio of gross non-performing assets (GNPAs) to gross advances.
– Nominal GDP Growth: An increase in nominal Gross Domestic Product (GDP) results in an increased demand for credit. The plummet in credit growth post-2013 was primarily due to a surge in bad loans, exacerbated by GDP slowdown.
– Deposit Growth: Deposit growth has been quite volatile since the second half of 2015. A financial institution with more funds at its disposal is better positioned to provide credit to borrowers.
– Investment Growth: An increase in investment growth contributes to slowed credit growth. If banks invest more in securities, they have fewer resources to extend as credit.
– Interest Rates: Greater interest rates lead to an increase in the cost of borrowing, which results in decreased demand for credit.
– Other Bank-specific Characteristics: Factors such as the size of the bank and capitalization also influence credit growth.
Measures taken to counter the slow credit growth
The RBI implemented several measures to counter the slowing of credit growth. It adopted an accommodative monetary policy stance and reduced the policy repo rate starting from 2019, which cushioned the credit deceleration. After the Asset Quality Review (AQR) in 2015, many hidden bad loans surfaced, prompting the government to enact the Insolvency and Bankruptcy Code (IBC) for resolution.
The future of credit growth in India
In India’s bank-dominated financial system, the credit channel plays a pivotal role in transmitting monetary policy impulses to the credit market and hence to the real economy. For monetary policy actions to render their full impact on the credit channel, addressing the asset quality concerns of banks and bolstering their capital positions is crucial.
Last Modified: February 9, 2024