Oil price hike is bad news for banks as credit growth slows

The unintended consequence of the UPA government not raising oil prices till recently was that banks got to lend more money to the oil companies.

A close look at the latest figures put out by the Reserve Bank of India (RBI) shows that credit growth was largely due to borrowing by the oil marketing companies (OMCs). If this borrowing comes down, credit growth can even become negative.

[caption id=“attachment_31901” align=“alignleft” width=“380” caption=“Correcting the credit course. Reuters”]  [/caption]

The OMCs have been borrowing heavily due to the losses suffered from selling fuel at prices lower than refinery-gate prices. OMC borrowings had crossed Rs 115,000 crore as of June 2011, almost doubling over the last few months, due to the sharp rise in crude oil prices.

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Brent crude prices had gone up by 25% over the last six months and the government, until 24 June, had not raised fuel prices to pass on the oil price rise. The OMCs suffered from the government’s dilly-dallying as the latter was not compensating them for their losses and they had to borrow from the system to make up the shortfall.

The fuel price hike and the customs and excise duty cuts by the government and the fall in crude prices are beneficial to the OMCs. Government actions have brought down the borrowing bills of the OMCs by Rs 50,000 crore, while the sharp fall in oil prices, with Brent crude falling by 20% from highs over the last few months, will help OMCs reduce losses.

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But lower borrowing by OMCs will bring down credit growth further, leading to a falling incremental credit-deposit ratio (ICDR) and higher systemic liquidity. This is a positive for bond yields as banks will buy bonds with their excess liquidity.

The ICDR is the ratio of growth in deposits to growth in credit. If credit growth is running higher than deposit growth, banks are actually drawing down on cash surpluses or selling investments or borrowing from the RBI to fund the credit growth.

The RBI’s credit data show that credit has grown by Rs 24,000 crore in the fiscal year to date (1 April-3 June 2011). In the same period, deposits have grown by Rs 53,000 crore, which takes the ICDR to 45%. ICDR was running at over 100% in the early months of this calendar year.

On the other hand, if deposit growth is running higher than credit growth, banks have surplus liquidity, which they use to buy bonds or keep it in liquid instruments.

Credit growth on a year-on-year basis has come down from the 23.5% levels seen in the beginning of this calendar to around 21% as of early June 2011. On an absolute basis, credit grew by Rs 47,000 crore in the period April-June 2010, almost double the growth seen in the same period in 2011. Last year also saw credit growing by Rs 115,000 crore between June and July after the auction of 3G spectrum licenses.

The sharp fall in credit growth year-on-year as well as on a fiscal year-to-date basis is due to the effects of monetary tightening and scam-related issues. The RBI has raised policy rates by 275 basis points (2.75%) over a 15-month period, leading to lending rates moving higher.

Banks have also tightened lending policies, especially to sensitive sectors such as telecom and real estate, after the 2G scam broke out in November last year. The country’s largest bank, the State Bank of India (SBI), has increased provisioning for bad loans in the fourth quarter of fiscal 2010-11.

SBI has also brought down its credit growth target for 2011-12 from 20% levels to 17% levels on worries of bad loans. Credit growth is expected to fall further on lower borrowing by the OMCs. Bond yields will benefit from falling credit growth but it does not augur well for the economy.

The author is editor www.investorsareidiots.com, a financial web site for investors.