July , 2024
Growing distress in India’s financial sector
23:09 pm

Dr. Rajiv Khosla

Since the onset of Covid-19, there has been a noticeable surge in the distribution of unsecured and high-risk loans by both banks and non-bank financial companies (such as Bajaj Finance, IFCI Limited, LIC Housing Finance, Aditya Birla Finance, etc.) across India. These loans, primarily in the form of personal loans and credit card loans, have also been extended by fintech companies (Groww, Policy Bazaar, Zerodha, etc.) and digital lenders (NeoGrowth, SmartCoin, Muthoot Microfin, etc.), particularly targeting India’s tech-savvy youth. However, this increase in personal loans, especially amidst historically high interest rates, rising unemployment, and a downturn in small business activities, suggests impending challenges. If these loans are not repaid on time, it could potentially trigger a widespread crisis in the Indian financial sector, affecting banks, non-bank financial companies, fintech firms, and digital lenders alike.

To prevent such a crisis, the Ministry of Finance and the Reserve Bank of India (RBI) have been issuing new guidelines regularly. In a directive issued in November 2023, the RBI mandated that banks and non-bank financial companies maintain higher cash reserves when issuing personal (unsecured) and credit card loans. This measure aims to safeguard financial institutions from significant losses in the event of loan defaults. Additionally, in May 2024, the RBI proposed that these financial lenders increase cash reserves for under-construction infrastructure projects (such as roads, bridges, and malls). This proposal seeks to avoid a repeat of the financial crisis experienced in 2012-13 when Indian banks faced substantial defaults. In a recent meeting with leaders of fintech companies, the RBI urged fintech and digital lenders to moderate their lending growth. These actions highlight the central bank’s concerns regarding the stability of India’s financial sector.

Statistics reveal that Indian banks are already grappling with a liquidity crunch. To address this shortfall, banks are either enticing deposits from the public with higher interest rates or borrowing funds from the market at elevated rates. Notably, the State Bank of India and Bank of India raised their interest rates in mid-May to mitigate the liquidity crisis by attracting public deposits. It is anticipated that other banks, both private and public, may follow suit. However, the public’s preference for long-term savings accounts or fixed deposits over current accounts is expected to keep banks’ interest servicing costs high for an extended period. Moreover, RBI directives requiring banks and financial institutions to hold higher cash reserves further diminish their profits.

The RBI has also advised the Indian government on measures to address banking liquidity issues. One such measure included the government repurchasing its securities (bonds) by paying off a portion of the outstanding debt before maturity, which the government agreed to. However, due to stringent conditions, banks showed limited interest in participating, resulting in the RBI managing to repurchase bonds worth only Rs. 17,849 crore, falling significantly short of the Rs.1.6 trillion target.

In a subsequent move on May 22, 2024, during the 608th meeting of the RBI Board chaired by Governor Shaktikanta Das, it was decided to pay a dividend of Rs.2.11 lakh crore to the Central Government for the financial year 2023-24. This dividend payment was more than double the government’s anticipated amount of around Rs.1 lakh crore, as mentioned in its interim budget. This substantial payment aims to achieve multiple

objectives: enhance banks’ liquidity, strengthen the central government’s financial health, momentarily alleviate the government’s need for new loans, and restore foreign investors’ confidence in the Indian stock market.

Importantly, it will also support additional expenditure in the upcoming budget of the new government in July, facilitating popular policy decisions. Thus, the RBI’s dividend payment of Rs.2.11 lakh crore to the government serves multiple purposes.

While beneficial to the government, these steps underscore unresolved challenges. On one hand, the government and RBI are tightening controls on high-risk lending; on the other hand, the central bank is ensuring liquidity availability. Banks, unable to keep RBI-provided funds unused, face risks from hasty lending practices. These actions reflect the RBI’s dual mandate of supporting the Indian government amid challenging economic circumstances.

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