The financial developments in the FY14-18 have changed the credit scenario in India, with imbalance in shares.
This calls for managing the credit needs better than now, with right mix in growth among banks, bonds, HFCs, and NBFCs.
What is the current credit scenario?
Estimates of unmet credit needs of creditworthy Indian companies and small entrepreneurs range from $500bn to $1tn.
In comparison, India’s current GDP is about $2.8tn and total outstanding credit is about $1.8tn.
Closing this gap would clearly boost economic growth materially.
In this context, private sector leverage in India (as measured by total private credit to GDP) is only a fraction of that in other large economies.
This calls for paying attention to managing the quality of credit growth and of the delivery channel.
Why is the recent credit crisis?
FY09-14 witnessed substantial amount of credit going for very large projects with lengthy durations for return of capital.
Notably, too much of banks’ balance sheets were utilised for these long-term projects, which should have ideally been fulfilled by bond markets.
But following the 2008 financial crisis, these large projects eventually led to vast majority of NPAs.
So in recent years, RBI went for tightening of norms for bad-loan recognition, and also imposed Prompt Corrective Action (PCA) on about half the public sector banks.
Due to this, the period FY14-18 has been one of significant deleveraging for Scheduled Commercial Banks (SCBs).
This refers to the reduction in the leverage ratio of banks, which is the percentage of debt in the balance sheet.
So during the FY14-18 banking deleverage, the bond markets and HFCs (housing finance companies)/NBFCs (Non Banking Financial Companies) initially filled some of the gap.
However, in 2018, bond issuance slowed down, driven by rising yields, reducing issuer appetite.
Subsequently, accelerating growth in credit from NBFCs/HFCs was also affected by the recent IL&FS crisis.
The commercial paper market too dried up and several HFCs and NBFCs had to sharply curtail disbursements.
What is the optimal credit share?
As a proportion of GDP, bank credit is roughly the same in India and the US which is the world’s broadest and deepest capital market.
However, total private credit is three times the proportion of GDP in the US relative to India.
This suggests that the big gap between outstanding credits in the two countries is primarily in bonds and NBFCs.
So credit from banks should continue to grow modestly faster than nominal GDP in India.
However, it is bonds and NBFCs that could grow significantly faster at this point.
What is the challenge?
The ways to shift the large project loans away from banks to corporate bonds is a huge challenge before India.
However, the shift can reduce asset-liability mismatch at banks as well as get banks to provide many more mid-size and smaller loans.
Perhaps India has not been innovative enough to expand credit without the corresponding increase in risks.
What can be done?
MSMEs - The MSME sector provides employment to 40% of the workforce and contributes about 37% of GDP.
It is in this underserved market that the gap between demand for and supply of credit is the greatest.
Also, key enablers (credit scores, formalisation of the economy, and the emergence of HFCs and NBFCs as low-cost origination channels) have emerged in this market.
So enabling credit growth to MSMEs (micro, small and medium enterprises) is a wise option.
MUDRA - The RBI's threshold is significantly higher for using MUDRA refinancing than classifying a company as an NBFC.
The criteria for MUDRA should be revised to enable a broader selection of NBFCs to qualify for refinancing MUDRA loans.
HFCs/NBFCs - On HFCs and NBFCs, the government and regulator need to take note of the changing landscape.
Currently, HFC and NBFC data is available from the RBI with a very significant lag.
It is not detailed enough to detect many inflection points and trends.
So monthly data reporting on sources of capital and on end-market credit exposure would help mitigate the build-up of unnecessary risk.
Bonds - Choice of bonds available to banks and insurance companies could be broadened.
Broadening the pool of potential buyers of bonds would likely boost the Indian corporate bond market and accelerate GDP growth.
In all, a significant portion of the Indian economy could grow a lot faster if its credit needs were better met.
