The objective of macro policy in a country is to achieve a steady rate of growth. To ensure steady growth, banks contribute to economic development by mobilizing small and scattered savings of the community and disbursing those as loans among enterprises. Banks are not passive intermediaries and help in transferring resources to new entrepreneurs. As money deposited may generally be for short-term while the loans may generally require long-term commitments, banks also perform the role of maturity transformation. The task of managing and monitoring risks associated with lending is also crucial to banking. Thus, banks play a crucial role in economic activity, innovation and entrepreneurship.
There are two views on the relationship between finance and growth. According to one view prevalent in 19th century, enterprise leads and finance follows implying that banks do not have a leading role in growth. The other view stresses complementarity between development and capital accumulation. So banks could finance investment in physical capital and growth in a proactive manner. In fact, in times of high credit growth from banks, in exuberance, quality standards could get compromised which are seeds to a crisis that follow thereafter. Long periods of prosperity and increasing value of investments lead to risky speculation using borrowed money. This culminates in a “Minsky Point” or a “Minsky Moment”, which is the starting phase of a financial crisis where the supply of credit dries up, causing a panic in the financial system.
To finance growth there are two alternatives – domestic financing and external sector financing. The implications of external sector financing are serious because of exchange rate risk as well as political ramifications. Consequently, the burden of financing growth is largely borne by domestic financing and therefore health of the corporate world gets integrated with the balance sheet of the banking sector. The slowdown of the economy immediately gets reflected in the increase of non-performing assets of the banking system. In India, in recent past, this relationship has emerged very transparently, especially in case of public sector banks (PSBs).
Historically, PSBs have been the backbone of Indian financial architecture since nationalization of State Bank of India (SBI) in 1955, followed by more banks in 1969 and 1980. These nationalised banks, PSBs, were created to pursue social objectives and focus on banking the unbanked. Consequently, PSBs, mainly SBI, have been in the forefront in rural areas and relentlessly pursuing implementation of welfare schemes of the government in terms of priority sector lending, and pension and insurance schemes, including those recently announced like Jan Dhan Yojana. Despite critical global conditions and turbulence in the Indian economy, PSBs have been successful in meeting their mandate of social banking and extending rural penetration.
In recent years, though the credit off-take has been lower than expected, capital adequacy of banks is relatively appropriate and deposit growth has been following a rather steady pace. However, NPAs of PSBs have increased significantly in recent quarters though the uptrend had been brewing for some time. In fact, PSBs finance largest amount of projects in infrastructure where large volumes of resources are required. Therefore, PSBs account for a substantially large share of stressed assets in mining, iron and steel, textiles, infrastructure and aviation as compared to private sector banks because of substantially larger exposure to these sub-sectors. Interestingly, in the early 1990’s, NPAs in PSBs were critically high but staged a smart recovery. In view of the fact, that NPAs in present context are explainable in terms of global meltdown or because of beggar-thy-neighbour behaviour of some neighbouring countries of India, recovery should not be a problem again, if concerted efforts are made.
Prof. Charan Singh, Indian Institute of Management (IIM), Bangalore, writes this piece for FICCI publication “Economy Watch”. Post continues on Page 2.
