Banks — the lifelines of an economy

A bank is a financial institution that accepts deposits and recurring accounts from the people and creates a demand deposit. Activities undertaken by banks include personal banking, corporate banking, investment banking, private banking, transaction banking, insurance, consumer finance, foreign exchange trading, commodity trading, trading in equities, futures and options trading and money market trading.

Narasimhan Committee II — 1998

The Banking Reforms Committee was set up to review the progress of the Indian banking system and propose reforms for strengthening bank legislations, ensuring capital adequacy, looking into bank mergers, and other aspects of financial system.

Narrow banking — Indian banks suffered from NPAs as high as 20 percent, which necessitated a reform to ensure that weak banks can only place their funds in short-term, and risk-free assets.

Capital-Adequacy Ratio — A high capital adequacy ratio is necessary to cushion a reasonable amount of losses until they become insolvent. It is used for maintaining the stability of financial systems and protecting the depositors. The committee recommended a raise in the CAR from 9% to empower the banks to have a greater absorption capacity.

Bank Ownership — The report stressed on the importance of banks enjoying a greater autonomy and independence to implement a professional corporate strategy.

This was accompanied with other changes in Banking rules and regulations, and recommendations for faster computerisation, technology upgradation, training of staff, depoliticising of banks, professionalism in banking, reviewing bank recruitment, etc.

CREDIT AMID PANDEMIC

The quarterly statistics bulletin of the RBI revealed insightful aspects about the Indian banking sector amid the coronavirus pandemic. Bank credit growth for March 2020 (Y-o-Y) recorded moderation across all population groups (rural / semi-urban / urban / metropolitan). Credit growth of both public sector and private sector banks at 4.2 per cent and 9.3 per cent, respectively in March 2020 was less than half the growth recorded a year ago. Metropolitan branches, which account for nearly 63 per cent of credit, recorded deceleration in credit growth to 4.8 per cent (Y-o-Y) in March 2020 from 13.5 per cent a year ago. The decrease in the credit growth can be attributed to the changes in several macroeconomic indicators amid the coronavirus pandemic. The low level of consumer and business confidence, increasing uncertainty, business closures, rising unemployment, falling wages, increase in indebtedness etc, have adversely impacted the disposable incomes and demand for credit by households as well as companies. Aggregate deposits of SCBs recorded marginal deceleration in growth to 9.5 per cent (Y-o-Y) from 10.0 per cent a quarter ago: metropolitan branches, which account for over half of aggregate deposits, witnessed significant moderation in deposit growth (6.9 per cent), whereas rural and semi-urban branches registered higher growth (15.5 per cent and 12.3 per cent, respectively). The marginal decrease in the deposit growth can be attributed to change in income levels and interest rates. Deposits are a function of interest rate and incomes levels, and a decline on both the independent variables has pulled down the dependent variable ( Deposits )

Interest rate in India

REPO RATE ( RBI )

It can be seen that the repo rate in India has been slashed to 4% in 2020. Repo rate refers to the rate of interest at which commercial banks borrow money from RBI. These cuts are usually employed when an economy encounters low aggregate demand, lowered output, and worsening economic conditions. The monetary therapy usually helps in stimulating the investment and consumer spending in the economy through low financing costs. The lowering of the repo rate manipulates the money supply and liquidity in the economy, empowering or disempowering the borrowing capacity of firms and households. However, the impact of the changes in monetary policy remains uncertain, because monetary policy is considered a more important instrument in decelerating the growth in aggregate demand, while fiscal therapy tends to be a more reliable instrument.

PUMPING MONEY INTO THE SYSTEM

RBI announced a reduction in the Cash Reserve Ratio (CRR) of all banks by 100 basis points to 3% of Net Demand and Time Liabilities with effect from the fortnight beginning March 28 for a period of 1 year. Cash reserve ratio sets the minimum limit of deposits, which must be held by commercial banks after lending money to borrowers. This includes all the balances of banks with other banks and demand deposits of the people. The measure to reduce the CRR would increase the money supply in the economy, with banks extending larger amount of money to businesses and households , thus boosting the aggregate demand in the economy, and leading to economic growth in the the prevailing recessionary trends under the pandemic.

WHAT AFFECTS THE DEMAND FOR LOANS BY CONSUMERS AND FIRMS

Consumer Confidence

Consumer confidence emphasises the optimism of consumers about the future of an economy and the prevailing economic conditions of a country. This determines the level of household spending in an economy, and subsequently affecting their demand for loans. There might be an increase in the household indebtedness due to falling wages, and rising unemployment, which would paralyse the ability of some households to pay the monthly loan payments. The unemployment rate in India on Jun 2020 experienced an exponential increase to a record-high of 23.5 %. This has led to the contractions in demand for loans in India. As it can be seen, the consumers express pessimism and believe that the economic conditions would not improve.

Business Confidence

The demand for credit or loans is directly proportional to the business confidence in the country. This measures how optimistic are firms about the macroeconomic indicators in a country. If the firms confront a situation of uncertainty, rising unemployment, lower output etc., they become apprehensive about making further investments in the economy, thus curtailing their plans for production, which would thus have a proportional impact on the demand for loans. The sharp fall in the BCI in April 2020 can be attributed to the uncertainty created by the situations under the pandemic, and a rising steepness of the curve of coronavirus cases.

NPAs and Capital Adequacy amid Pandemic

The capital adequacy ratio for a system of 53 banks is projected to come down to 14.1 percent by September 2020 from 14.9 percent in September 2019. Three banks may see their capital adequacy ratio go below the minimum regulatory level of 9 percent by September 2020 without considering any further planned recapitalisation.Under a severe shock if the gross NPA ratio of 52 select scheduled commercial banks moves up to 15.6 percent from 9.4 percent, the system-level capital adequacy ratio will decline from 14.9 percent to 11.2 percent, the RBI said. Public sector banks would be severely impacted with the capital adequacy ratio of 16 of the 19 state-run lenders likely to fall below 9 percent in case of such a shock. India was already experiencing a comparative disadvantage with high NPAs and low recovery rates, and the pandemic would even aggravate the crisis. This points towards a rise in the gross bad debts in the economy, thus leading to a greater crisis for the Indian banking system. This necessitates the urgency of a larger recapitalisation plan for PSBs and PVBs as the normal capital requirements may not be enough to absorb losses.

Student at Kiit International School. Passionate about research in business, political science, current affairs and economics.