by Vivek Kaul
The insinuation here is that, if Rajan had cut the interest rates fast enough, the middle class would have borrowed and spent. This would have reinvigorated the Indian economy. This, as we have seen in the previous section, is not true. Retail lending in 2015-2016 has been the strongest in many years. So, clearly Mitra wrote his column without bothering to look up the figures.
Figure 11.3(a): Non-food credit growth over the past two years for both PSBs and private banks (in %).
Source: Reserve Bank of India.
In fact, a few days after deciding to return to academia, Rajan made a speech in which he explained his entire economic philosophy. He made it clear in his speech, while employing pertinent data, that interest rates hadn’t held back bank lending. As he said: “The slowdown in credit growth has been largely because of stress in the Public Sector Banking, and not because of high interest rates.”650 Take a look at Figure 11.3(a).
The top curve shows the overall lending growth of the new-generation private sector banks (Axis Bank, HDFC Bank, ICICI Bank and IndusInd Bank) over two years, from April 2014 to April 2016. What this shows very clearly is that the lending growth of the new-generation private sectors banks has had an upward trend, with a few small blips in between.
In contrast the lending growth of PSBs, the bottom curve, has slowed down considerably over the past two years. Let’s look at the bank lending growth in a little more detail. Figure 11.3(b) shows the bank lending growth to industry between April 2014 and April 2016.
Figure 11.3(b): Credit growth to industry over the past two years for both PSBs and private banks (in %).
Source: Reserve Bank of India.
As can be seen from Figure 11.3(b), the growth in loans given to industry carried out by the new-generation private sector banks (the top curve) has been robust. In fact, between April 2015 and April 2016, the lending carried out by these banks to industry grew by close to 20 per cent. Hence, the new-generation private sector banks have been lending to industry at a very steady pace.
The same cannot be said about the PSBs. Their lending growth to industry has been falling since April 2014. This led many people to believe that high interest rates have slowed down bank lending. As Rajan put it: “The immediate conclusion one should draw is that this is something affecting credit supply from the PSBs specifically; perhaps it is the lack of bank capital.”651
But, as mentioned earlier in the chapter, both PSBs as well as private banks have been happy to lend to the retail sector. Retail loan growth stood at 19.4 per cent in 2015-2016. Furthermore, retail loans formed 41.5 per cent of all non-food credit given out by banks.
This is precisely the point that Rajan made in his speech. Take a look at Figure 11.3(c), in which the retail lending growth of PSBs (the lower curve) and new-generation private sector banks (the upper curve) have been plotted. (The RBI refers to retail loans as personal loans, which are not to be confused with what banks call personal loans.)
Figure 11.3(c): Growth in retail loans over the past two years for both PSBs and private banks (in %).
Source: Reserve Bank of India.
As can be seen, the two curves are almost about to meet. What this tells us is that, when it comes to lending to the retail sector, the public sector lending growth is almost as fast as that of the new-generation private sector banks. What one also needs to point out here is that PSBs are lending on a bigger base. And that possibly explains why their retail loan growth is not as fast as that of the new-generation private sector banks, even though it is pretty good on its own.
As Rajan put it in his speech:652
If we look at personal loan growth, and specifically housing loans, PSB loan growth approaches private sector bank growth. The lack of capital [for PSBs] therefore cannot be the culprit. Rather than an across-the-board shrinkage of public sector lending, there seems to be a shrinkage in certain areas of high credit exposure, specifically in loans to industry and to small enterprises. The more appropriate conclusion then is that PSBs were shrinking from exposure to infrastructure and industry risk right from early 2014 because of mounting distress on their past loans.
This isn’t surprising, given that PSBs are carrying a huge amount of bad loans on their books due to lending to industry. As the old Hindi proverb goes, “Doodh ka jala chaach bhi phook-phook kar peeta hai” (Once bitten, twice shy).
Take a look at Figure 11.3(d), which plots the home loan lending growth of PSBs and new-generation private sector banks.
In this case, the lending growth of PSBs (the lower curve) is about as fast as the lending growth of the new-generation private sector banks (the upper curve). What all this tells us very clearly is that, when it comes to the retail segment, PSBs are lending as much as they can. This refutes Chandan Mitra’s point when he said that the middle class isn’t borrowing and spending because of high interest rates. If the middle class weren’t borrowing and spending, retail lending wouldn’t have grown by close to 20 per cent in 2015-2016.
Figure 11.3(d): Growth in home loans over the past two years for both PSBs and private banks (in %).
Source: Reserve Bank of India.
Table 11.5: Types of bank retail lending between 2014 and 2016.
Type of Retail Lending Growth in 2014-2015 (in %) Growth in 2015-2016 (in %)
Consumer Durables 19.3 16
Housing 16.7 18.8
Loans against Fixed Deposits −1.7 6.7
Loans to Individuals against Shares, Bonds, etc. 42.2 18.1
Credit Card Outstanding 22.6 23.7
Education 5.5 7.7
Vehicle Loans 17.2 22.7
Other Personal Loans 18.3 25.2
Source: Sectoral Deployment of Credit Data, RBI.
Take a look at Table 11.5. It shows the growth in the different types of retail lending. Other than loans to individuals against shares, bonds, etc. and loans to buy consumer durables, every other kind of lending has improved in 2015-2016 in comparison to 2014-2015.
Rajan summarised it best when he said:653
These charts refute another argument made by those who do not look at the evidence – that stress in the corporate world is because of high interest rates. Interest rates set by private banks are usually equal or higher than rates set by PSBs. Yet their credit growth does not seem to have suffered. The logical conclusion, therefore, must be that it is not the level of interest rates that is the problem. Instead, stress is because of the loans already on PSBs’ balance sheets, and their unwillingness to lend more to those sectors to which they have high exposure.
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Another thing that needs to be pointed out here is that, after many years, the Indian saver is actually getting a real rate of return on his savings. This has happened primarily because the rate of interest offered on fixed deposits and other deposits is now higher than the rate of inflation.
As Rajan said in a June 2016 television interview: “When inflation was 9 per cent, they [i.e., depositors] were getting 9 per cent. This meant earning nothing in real terms and losing everything in inflation.” Now the inflation is 5.5 per cent and the rate of interest is 7 per cent. This means that the depositors are finally able to make some real rate of return on their deposits.
This wasn’t the case for many years. As Rajan explained in a June 2016 speech: “In the last decade, savers have experienced negative real rates over extended periods as CPI [inflation as measured by the consumer price index] has exceeded deposit interest rates. This means that whatever interest they get has been more than wiped out by the erosion in their principal’s purchasing power due to inflation. Savers intuitively understand this, and had been shifting to investing in real assets like gold and real estate, and away from financial assets like deposits.”654
Figure 11.4 clearly shows that, between 2008 and 2013, the real rate of return on deposits was largely negative. In fact, it was close to 4 per cent in the negative territory in 2010. The real rate of return on deposits is essentially the difference between the nominal rate of interest and
the rate of inflation.
Figure 11.4: The average real rate of return on deposits (in %) between 2002 and 2013.
Source: Economic Survey of 2014-2015.
High inflation essentially ensured that India’s gross domestic savings have been falling over the past decade. Between 2007-2008 and 2013-2014, the rate of inflation, as measured by the consumer price index, averaged around 9.5 per cent per year. In 2007-2008, the gross domestic savings peaked at 36.8 per cent of the GDP. Since then, they have been falling, and in 2013-2014, the gross domestic savings were at 30.5 per cent of the GDP, having improved from a low of 30.1 per cent of the GDP in 2012-2013.
This fall in gross domestic savings has come about because of a dramatic fall in household financial savings. Household financial savings is essentially a term used to refer to the money invested by individuals in fixed deposits, the small savings schemes of India Post, mutual funds, shares, insurance, provident and pension funds, etc. A major part of the household financial savings in India is held in the form of bank fixed deposits and post office small savings schemes.
Between 2005-2006 and 2007-2008, the average rate of household financial savings had stood at 11.6 per cent of the GDP. In 2009-2010, it rose to 12 per cent of the GDP. By 2011-2012, it had fallen to 7 per cent of the GDP. The household financial savings in 2014-2015 stood at 7.5 per cent of the GDP.
If a programme like Make in India has to take off, India’s household financial savings, in particular, and overall gross domestic savings, in general, need to be on solid ground. And that is only going to happen if people are encouraged to save by ensuring that they make a real rate of return on their deposits. In fact, if India needs to grow at 10 per cent per year, an estimate suggests that the domestic savings rate would have to be around 41 per cent of the GDP.655
As Rakesh Mohan and Munish Kapoor of the International Monetary Fund write in a research paper titled ‘Pressing the Indian Growth Accelerator: Policy Imperatives’: “In the near future, we expect financial savings to be restored to the earlier 10 per cent level as inflation subsides, monetary conditions stabilise and households begin to obtain positive real interest rates on their deposits and other financial savings. Financial savings are then projected to increase gradually to around 13 per cent by 2027-2032.”656
And how is this going to happen? As Mohan and Kapoor point out: “A sustained reduction in inflation that leads to the maintenance of low nominal interest rates, but positive real interest rates, will help in restoring corporate profitability while encouraging household savings towards financial instruments.”657
Given this, it is safe to say that Rajan was absolutely on the right track with his interest rate policy. What India currently needs is a high-savings interest rate because, ultimately, these savings will translate into investments.
If Make in India manages to take off without the domestic savings rate going up from its current levels, then companies establishing industries would have to borrow from abroad, and this, beyond a certain level, has its own share of repercussions.
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In August 2015, the government laid down the Indradhanush reforms, which was basically a plan to revamp the PSBs. The important features of the plan are as follows:
a)The post of the Chairman and Managing Director of a PSB has been split. In the days to come, one individual will be appointed as MD and CEO of a bank and another as its non-executive chairman. This move was in line with the best global practices. Furthermore, individuals from the private sector are now allowed to apply for the posts of MD and CEO of PSBs which are vacant at that point of time.
b)A Bank Board Bureau (BBB) has been set up. The BBB, it was said, would be a body of eminent professionals. The former Comptroller and Auditor General, Vinod Rai, has been appointed as its first head. Its job is to appoint the whole-time directors as well as the non-executive chairmen of the PSBs. Furthermore, the BBB is also expected to “constantly engage with the Board of Directors of all the PSBs to formulate appropriate strategies for their growth and development”.658 The BBB started to function from April 1, 2016.
c)The government also planned to infuse more capital into the PSBs. As the Indradhanush Document pointed out: “If we exclude the internal profit generation which is going to be available to PSBs (based on the estimate of average profit of the last three years), the capital requirement of extra capital for the next four years up to FY 2019 is likely to be about Rs. 1,80,000 crore.”
Of this, the government planned to pump in Rs. 70,000 crore (see Table 11.6). The remaining Rs. 1,10,000 crore the banks will have to raise from the market on their own. As I write this, in early July 2016, the PSBs are clearly not in a position to raise this kind of money on their own from the financial markets. The good bit is that the government has linked some part of the recapitalisation to the performance of the banks.
What is interesting is that the government’s estimate of the amount of capital needed by the banks over the next few years is much lower than other estimates that have been made.
Table 11.6: Current and projected Indradhanush capital requirements.
Year Amount
(in Rs. crore)
2015-2016 25,000
2016-2017 25,000
2017-2018 10,000
2018-2019 10,000
Source: Indradhanush Document, Ministry of Finance.
As mentioned earlier, the PJ Nayak Committee thinks that banks will need a capital of Rs. 5.87 lakh crore. The Committee further assumes that, if the government puts in 60 per cent of the amount, then it would need Rs. 3.5 lakh crore.
Another estimate, made by Viral Acharya, of the Stern School of Business, and Krishnamurthy V Subramanian, of the Indian School of Business, in a research paper titled ‘State intervention in banking: The relative health of Indian public sector and private sector banks’, suggests higher numbers. The professors come up with three scenarios. In what they call the extremely prudent scenario, they feel that the PSBs would require around Rs. 9,97,400 crore of capital. In the less prudent scenario, banks would need Rs. 6,53,300 crore of capital. In the least prudent scenario, banks would need Rs. 5,12,300 crore of capital.659
Let’s compare these figures with the market capitalisation of the listed PSBs as on July 7, 2016, i.e., on the day I am writing this. (Some of the smaller PSBs are not listed. But this won’t make any material difference to the overall result.) The total market capitalisation of the PSBs is around Rs. 3,66,500 crore.
This means that the amount of capital required under the three different projected scenarios comes out to 2.7 times, 1.8 times and 1.4 times, respectively, of the total market capitalisation of the PSBs. What this clearly tells us is that a lot of money will be required in order to recapitalise the PSBs. Interestingly, as far as the new-generation private sector banks go, the capital required by them in the three scenarios comes out to Rs. 9,540 crore, Rs. 4,980 crore and Rs. 1,350 crore, respectively. This tells us very clearly that the new-generation private sector banks are much better capitalised than their public sector counterparts.660
It also shows us very clearly another negative impact of Big Government. In fact, the total amount of capital that PSBs have had against their risk-weighted assets has been falling over the years. Banks need to maintain some capital against the lending that they carry out. Different kinds of lending have different levels of associated risk: like lending to the government has zero risk, and hence, banks do not need to maintain any capital against the government bonds they buy. On the other hand, lending to a real estate company is deemed to be significantly risky, and the banks need to maintain some capital against this lending. This is essentially to make sure that the banks have an adequate amount of capital against the lending that they carry out. Hence, the capital-to-risk-weighted-assets ratio is also referred to as the capital adequacy ratio.
Figure 11.5 shows very clearly that, until March 2015, the capital-to-risk-weighted-assets ratio of the PSBs had been falling (the bottom most curve). As of Marc
h 2015, the ratio was under 12 per cent. In March 2016, the ratio was at 11.6 per cent. In comparison, the ratio for the private sector banks was at 15.7 per cent.
The capital adequacy ratio for PSBs has fallen over the years primarily because of the bad loans that they have accumulated. Some of these bad loans have been settled against the capital that the banks have, and this has led to the overall ratio falling. The ratio would have fallen even more if the government hadn’t put a significant amount of money into these banks. Between September 2009 and August 2016, the government invested close to Rs. 1,25,000 crore in the PSBs. This is a significant amount of money. Despite this investment, the capital adequacy ratio of the PSBs has come down.
Figure 11.5: The capital adequacy ratio of banks between March 2011 and March 2015 (in %).
Source: RBI Financial Stability Report.
PSBs = Public Sector Banks. PVBs = Private Banks. FBs = Foreign Banks. SCBs = Scheduled Commercial Banks.
As per the RBI norms, banks need to maintain a capital adequacy ratio of at least 9 per cent. Hence, on an average, the PSBs are above the level that is deemed to be safe. Nevertheless, if banks have to take some risks while lending, they prefer to keep their capital adequacy ratio at about 5 per cent (or 500 basis points) above the level deemed to be safe by the regulator. This, in the Indian case, means a capital adequacy ratio of 14 per cent.661
The PSBs are nowhere near that level. In fact, the top three PSBs by assets, the State Bank of India, the Bank of Baroda and Punjab National Bank, had capital adequacy ratios of 13.1 per cent, 13.2 per cent and 11.2 per cent, respectively, as on March 31, 2016.
Over and above the bad loans eating into the capital of PSBs, the Basel III norms come into force from 2019. Basel is a small town in Switzerland where the countries of the world come together to decide the amount of capital that banks should be holding against their assets. The Basel III norms mandate more capital to be held against banks’ assets in comparison to the Basel II norms.