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India needs to address systemic issues for banks to step up lending

India's banking system is now awash in liquidity but the authorities need to address several systemic issues for more credit to flow to the productive sectors battered by the COVID-19 pandemic, analysts say.

Recent measures, including lower interest rates, billions of dollars in fresh funding for lenders, payment moratorium and relaxation in recognizing nonperforming loans have significantly increased market liquidity in general. However, the government should step up pushing banks to improve their sector-based lending practices and encourage them to take reasonable risks to extend loans to borrowers with weaker credit profiles, according to the analysts.

After surprising the market on March 27 with its steepest rate cuts since 2009, the Reserve Bank of India lowered its overnight borrowing rate by another 25 basis points to 3.75% on April 17, reducing the incentive for banks to park their surplus funds with the central bank. It also announced regulatory easing measures for banks and shadow banks.

"The RBI's measures are a nudge, but a bigger shove will be necessary to meaningfully reverse banks' risk aversion," Nomura Holdings Inc. said in a note after the central bank's unscheduled announcement on April 17.

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More may be needed

Nomura expects the central bank to announce more easing steps, both via a conventional policy response of reducing benchmark rates, and also unconventional steps. The markets expect the central bank may announce open market operations or even private placements of government securities, Nomura said.

RBI Governor Shaktikanta Das said the central bank will monitor the situation continuously and "use all its instruments to address the daunting challenges posed by the pandemic." The central bank's "overarching objective" is to keep financial system and financial markets sound, liquid and smoothly functioning so that financing keeps flowing to all stakeholders, he said.

"Policy transmission remains a key challenge in India as excess liquidity is not benefiting all entities. Smaller and lower rated entities continue to see tight credit conditions due to their elevated credit risk premia in an environment of weak economic growth," Nomura said. The Japanese brokerage expects the Indian economy to contract 0.5% this year, compared with a 5.3% growth in 2019.

The demand for loans has to be driven by companies and industries that may continue to struggle or operate below optimal levels for the next two-to-three quarters due to the disruption caused by the novel coronavirus pandemic, said Sandeep Upadhyay, the chief executive of Centrum Infrastructure Advisory Ltd.

"The intent to lend has to be seen in the context of bankers feeling comfortable about lending in this difficult environment with the underlying risk of being subjected to scrutiny later for their decisions," Upadhyay told S&P Global Market Intelligence.

Indian Finance Minister Nirmala Sitharaman acknowledged that state-run banks' lending decisions were being clouded by the fear of investigation by federal anti-corruption agencies and assured their leadership that their executives won't be harassed for genuine commercial failures.

"This systemic issue needs to be addressed in the backdrop of prudent lending norms," Upadhyay said.

A part of addressing the systemic problems has to do with enhancing sector-based expertise in the Indian banking system, and another aspect is to encourage merit-based lending without the fear of investigating agencies. "The mindset of the bankers has to change, especially in this difficult market," he said.

Credit quality

The RBI last week asked banks to make general provisions of 10% to cover all accounts where creditors granted a moratorium on repayment to the borrowers or deferred recovery of interest on working capital facilities. Borrowers were earlier allowed to delay their repayments by three months to tide over the stoppage of business activity due to the virus outbreak.

"There will be some slippage in loan repayments as cash flow will be a problem for many businesses. That is why the RBI is asking banks to make accelerated provisioning upfront," said Sameer Narang, the chief economist at state-run Bank of Baroda.

However, banks will be better prepared when the moratorium ends as the 10% provisioning will be a buffer to take care of the slippage. It may be too early to assess the full impact, but not all accounts will slip and the preemptive provisioning will help maintain financial stability, he said.

The lack of demand has been another drag on the Indian economy, Narang said. For example, auto sales have stayed weak for several quarters and that weak demand environment is adding to banks' aversion to lend, he said.

The challenge of banks' reticence to take lending decisions is more for the bigger corporate loans as the ecosystem for other sectors is fairly well developed, Narang said, adding, what is required is a more developed corporate bond market. The central bank's long-term repo operations, or TLTROs, are meant to nudge companies toward the bond market, rather than depending on bank loans as the main source of funds, he said.

The central bank announced fresh funding of 1 trillion rupees via TLTROs for banks on March 27, and another 500 billion rupees of TLTROs targeted at providing funds to nonbank financial institutions and microfinance institutions on April 17. It also announced 500 billion rupees of fresh funds to federal institutions that lend to financial institutions in agriculture, small scale industry and housing sectors.

Among other measures, the central bank stopped banks from announcing dividend payments to conserve cash, temporarily brought down their liquidity coverage ratio requirement to 80% from 100% prior and said loan accounts that are offered a moratorium on payments won't be classified as bad loans during the standstill period.

As of April 21, US$1 was equivalent to 76.96 Indian rupees.