Declining trend in bank credits to productive sector must be reversed!

For a vibrant and growing economy, India needs both wheels of the economy, a strong and stable bank for financing the productive asset along with a motivated entrepreneur to manage such productive assets, expresses R P Gupta, Economist & Author of Turn Around India.

We must acknowledge that investment in the productive sector is the primary need for the growth of public income (GDP) as well as for boosting investment; liberal Bank credit is the most crucial need. The impediments, if any, must be removed. 

During the developing phase of any nation, the major portion of bank credit should be deployed in productive assets, instead of financing consumption needs. The share of personal loans has increased from 18 per cent of bank credit (excluding SLR) in 2012 to about 28 per cent in 2020; that needs correction. However, the share of housing loans should continue.  

Sector-wise break up bank credit (excluding SLR loan) share in per cent: 

Source: *From the book - Turn around India ** from RBI website. The figures are rounded off. 

The anxiety of NPA has restrained bankers from extending credit to the productive sector, particularly to the MSME sector. Intermittent and temporary loss in any business is unavoidable. In India, the risks are somewhat enlarged due to regulatory and tax hazards. In the sequel, the entrepreneurs are also hesitant for availing credits and expanding business. 

We should acknowledge that the banks and the entrepreneur are two wheels of the economy. Business risks must be shared among both wheels. The financial sector must supplement and not disrupt the real economy. Current regulations protect banks but not the entrepreneurs; they have invested the seed capital and mortgaged personal assets. In the future, they might not prefer taking a business risk by engaging in productive activities. If so, who will drive the Indian economy and generate jobs? 

Existing NPA norms are not sacrosanct; these must change as per the economic needs of India. The classification of any productive asset as NPA (non-performing asset) must be based upon its medium/long-term viability and not upon the temporary mismatch of cash flow, causing default in debt servicing. By this, India is losing both, the bank’s capital as well as the productive asset. 

India is not yet ready for adopting such stringent norms till its economy attains maturity. These norms are causing more harm than good to the banks besides damaging the economy. India must revisit NPA norms and restore loan restructuring for protecting productive assets, which generate public income (GDP) and government revenue.  

NPA norms may be extended from 3 to 6 months. Restructuring of loans may be re-instated for the viable business. Typical tools of restructuring such as longer repayment, funding of interest, partial waiver of dues, and the conversion of part dues into equity may be allowed as per the wisdom of banks. This will protect both, the productive asset and the bank’s money. Few failures should not be a reason to question the wisdom of banks. 

As per past experience, the insolvency process is causing huge losses to banks, operational creditors as well as shareholders apart from affecting the entrepreneurial spirit. Hence, it may be restricted to the errant promoters or in such a case, needs relief from the operational creditors for the viability of the business. 

While extending liberal credit, an element of credit risk is obviously involved despite prudent appraisal. So as to mitigate partial risk, a Self-insurance mechanism may be introduced. For this, the interest rates may be hiked by 0.50 to 0.70 per cent across the board and this additional interest may be treated similar to ‘self-insurance premium’. This premium should be transferred directly to ‘contingency reserve’, bypassing the profit & loss account. RBI and Government may allow such changes in the accounting standard. These reserve funds with banks may be used for the provisioning of NPA accounts, in part or full.  

This mechanism will increase the cost of borrowing. However, it will protect banks from the loss arising due to NPA provisioning to a large extent. By this, the financial stability of banks will improve and their market capitalisation shall also upsurge. Thereafter, for further mitigation of credit risk, banks should increase their capital base by raising equity capital and/or bonds from the capital market.  

For a vibrant and growing economy, India needs both wheels of the economy, a strong and stable bank for financing the productive asset along with a motivated entrepreneur to manage such productive assets. Mutual trust and team spirit are the keys to success. The wrongdoings of a few errant promoters should not be a reason for enforcing the stricter regulations to such an extent, which is not compatible with the economic needs of India.