Economic revival: RBI rate cut no magic wand as banks stare at rising stress

Even as some banks have begun to respond to the rate signal from the Reserve Bank of India (RBI) by reducing their lending and deposit rates, this is unlikely to trigger the much-needed pick up in loan growth to the core sector, enabling faster economic growth. Reasons: Persisting stress on the balance sheets of most of the banks, especially state-run lenders, from infrastructure loans, are acting a major dampener for banks to take further exposure to same-class of assets. Second, the capital headroom available to state-run banks, remains painfully limited. Fresh signs of stress emerging from infrastructure loans are evident in the December loan recast numbers, even though, overall, fresh cases of restructuring has come down a bit. The proportion of infrastructure loans to the total chunk of restructured loans under the corporate debt restructuring (CDR) channel grew to 22 percent, or Rs 58,554 crore. CDR is a mechanism under which banks offer relaxed repayment terms to a stressed borrower to aid the firm tide over the crisis. [caption id=“attachment_2059001” align=“alignleft” width=“380”]  ThinkStock[/caption] If one reads this number with the iron and steel sector loans, which are under stress, the picture turns clearer. About Rs 45,000 crore is the iron and steel sector loans being recast only through the CDR channel. Banks also do bilateral loan recasts, which would make the actual figure much higher. To be sure, infrastructure has topped the list of CDR loans for the past many years, but what is to be noted is the quantum of stressed assets refuses to fall despite efforts from the government to prop up sentiment in a sagging economy. This, also evident from the higher number of firms exiting the CDR due to failure, isn’t a good sign. Such stress, mostly on the books of state-run banks, is holding back banks from going for further expanding their loan book in spite of a strong signal from the RBI to start cutting lending rates to spur demand and contribute to the revival. Remember, banks have been cutting their deposit rates for the last five months, which typically should be followed by a cut in their lending rates. But banks haven’t gone for any major lending rate cuts yet. Even after the RBI’s surprise rate cut and benign language, only two banks—Union Bank of India and United Bank of India—have cut their base rates, while others have so far offered a cold response to the calls for lending rate cuts. Also, these banks, with a quarter percentage point cut to 10 percent, have merely aligned their base rate with that of other banks. In the weeks ahead, banks would indeed go for some reduction in their lending rates but that is likely to be merely cosmetic than any meaningful rate action. Banks may also go for cuts in their deposit rates further to discourage further inflow of funds. Going ahead, even if the central bank goes for further rate cuts heeding the growth calls from the government, banks’ response is likely to be minimal unless the stress situation eases. Total gross bad loans on banks’ balance sheets have already grown beyond Rs 2.7 lakh crore, which, coupled with restructured advances, takes the actual chunk of stressed loans in the banking sector to above 10 percent of the total loans given. Higher bad loans impact the profitability of banks since banks have to set aside money to cover such loans. “In a scenario, where there is immense stress from bad loans, why would banks take further exposure to risk,” asked a senior official at a state-run bank. He didn’t want to be named. This puts the ball back in the court of the government to act fast to get the stuck projects back on track and pave way for fresh investments at the earliest to resolve the deadlock. Rate cuts alone wouldn’t do the job when it comes to reviving a battered economy. The solution should emerge on the ground. Unless domestic banks resume lending, there can’t be any real growth since private investors are still hesitant to try their luck in Indian infrastructure projects, marred with clearance delays and also due to the fact that government might not be in a position to ramp up public expenditure. In a recent note, Singapore-based had said that a rate cut by the Reserve Bank of India is not a “panacea” to revive low credit growth. Banks are unlikely to transmit any of the cuts to their loan pricing, DBS said. “Rate cuts are unlikely to be a panacea for credit activity, even if a handful of banks jump into the easing bandwagon this week,” DBS said in a note soon after the RBI rate cut last week. That apart, the pain from stressed assets, state-run banks, which control 70 percent of the banking industry assets, still have very limited capital headroom to go for large-scale expansion of their loan books. It remains to be seen to what extent the government will fulfil the capital requirements of these entities or lay down a roadmap for this. A clear picture on this will emerge in the Union Budget on 28 February.