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  • OUTLOOK ARENA  >>   VIEWS ON NEWS >>  JULY 7, 2004

    Banking: Entering a new stage

    The banking and finance sector in the country saw significant policy changes in financial year 2003-04, following the reforms path set up by the previous government in 2002-03. There were also certain changes that were precipitated by the changing demographic nature of the country. As far as the lending operations of the banking sector are concerned, the year was rather lackluster, but the trends in the last two quarters of the year show an encouraging picture.

    Before we elaborate on the performance of the banking sector in 2003-04 (FY04), as highlighted by the Economic Survey, it is important to assess the monetary policy environment in the country. The objectives of the monetary policy have not changed in FY04 and the policy continued to focus on maintaining adequate liquidity in the system to boost credit growth so as to provide a fillip to the investment demand in the economy. The central bank's (Reserve Bank of India (RBI)) monetary policy also stressed on maintaining a soft interest rate bias.

    Low levels of inflation during FY04 also helped the RBI in meeting its monetary objectives. The year was also characterized by strong inflows of private capital (FII, FDI and remittances and deposits by NRIs). The surge in private capital flows resulted in excess liquidity, which further helped RBI maintain a low interest rate scenario. During the year, the RBI reduced the bank rate and Cash Reserve Ratio (CRR) by 25 basis points each to 6% and 4.5% respectively.

    During 2003-04, there were certain key reform measures in the banking sector that were proposed including risk based supervision, issuance of guidelines for the Securitisation Act and enhanced limits for FDI in the sector. The RBI was also instrumental in enforcing a fall in lending rates, however not to the extent that was intended. Due to a falling interest rate regime, banks were able to lower deposit rates significantly. However, lending rates witnessed significant downward rigidity in FY04. Between FY02 and FY04, while deposit rates have fallen to the 5.0% to 5.5% range from the 7.5% to 8.5% range, lending rates (Prime Lending Rates) have only fallen to the 10.25%-11.5% range from the 11%-12% range.

            Growth (%)
    (Rs bn) FY02 FY03* FY04* FY03 FY04
    Gross bank credit 5,367 6,695 7,644 24.7% 14.2%
    Public food credit 540 495 360 -8.3% -27.3%
    % of gross bank credit 10.1% 7.4% 4.7%    
    Gross non food credit 4,827 6,201 7,284 28.4% 17.5%
    % of gross bank credit 89.9% 92.6% 95.3%    
    Retail credit 335 517 679 54.4% 31.2%
    % of gross non food credit 6.9% 8.3% 9.3%    
    Housing sector credit 223 366 520 63.7% 42.1%
    % of gross non food credit 4.6% 5.9% 7.1%    

    * Includes the impact of the merger of ICICI and ICICI Bank

    Due to the rigidity in lending rates, credit growth was lackluster as far as the medium industries are concerned. Credit to the SSI sector also sluggish. While larger and 'AAA' corporates were able to garner credit at below PLR, due to the lack of downward flexibility of lending rates, the impetus for the medium and SSI sector for borrowing was absent. While the overall gross bank credit grew by over 14%, non-food credit grew by nearly 18%. Credit growth to the medium sized industry stood at 5% while the SSI sector grew by 9%.

    Credit to the retail segment was the main factor that led to the overall growth in credit. Housing and consumer durable sectors saw large offtake. Credit to the housing sector rose by 42% in FY04 on top of a 55% rise seen in FY03. The retail segment currently accounts for over 8% of the outstanding non-food credit compared to over 6% in FY02. On an incremental basis, the credit flow to these sectors account for over 15% of total flow of non-food credit. There has been a consistent rise in credit to the agriculture sector as well (17.5% in FY04 compared to 17.5% in FY03).


    The RBI expects the flow of private capital into the country to be maintained in the medium term and this is likely to put pressure on the central bank's efforts to control liquidity and the value of the Indian Rupee. At the same time, the banking and finance sector is witnessing a revival in credit offtake from the non-food segment. Though this is a positive for the sector, any rise in interest rates may take a toll on incremental demand. Recent data on inflation has had an impact, as indicated by the rise in the 10-year bond yield. Thus, the banking sector is faced with the challenge of rising interest rates together with a revival in credit offtake. Also, with the government emphasizing on the need to boost credit to the agri sector, the issue of NPAs could resurface. While we believe that overall credit growth is likely to move into a higher growth trajectory as compared to the past, not all banks will be able to reap the benefit from such sector trends. In the past, falling interest rates have helped most public sector banks to significantly improve their profitability owing to large profits from trading activities. With interest rates expected to harden, these profits may dry out, thus affecting profitability. Investors need to tread cautiously at this stage, as only a few banks will be able to balance the growth prospects together with the emerging concerns in the sector.

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