State-run banks should not repeat the lending mistakes of the 2000s

The total outstanding credit of commercial banks crossed 50% of gross domestic product (GDP) for the first time in 2008-09. Since then, it has moved in the range of 50-53%, except in 2020-21, when it stood at 55.3%, but that was because the size of the economy (its GDP) shrunk during the year. As of March 2022 and September 2022, the outstanding credit of commercial banks stood at 50.3% of GDP.

So, the question is why have Indian banks stopped growing at a faster pace than the economy? To answer this question, we have to go back a bit in history. The outstanding credit of Indian banks reached a high of 21.4% of GDP in 1989-90. Around this time, public sector banks (PSBs), which dominated a large part of the banking system in India, were hit with bad loans that were not repaid. In 1992–93, the bad-debt rate of PSBs was 23.1%, which rose to 24.8% in 1993–94. This ensured that the outstanding credit of commercial banks remained stable during the 1990s, surpassing the peak hit in 1989-90 only in 1999-00, when it touched 21.9% of GDP. After that, there was no looking back for more than a decade.

This was because the bad loan rates of PSBs had fallen, encouraging them to lend at a faster pace. The bad loan rate of PSBs fell from a little over 11% in 2001-02 to a low of 2% in 2008-09.

Between 1999-00 and 2009-10, PSB credit grew at a whopping 22% per annum. A large part of this money was loaned to industries for all kinds of new projects. The trouble is that any economic system can only borrow a certain amount of money and no more, for the simple reason that the loaned money needs to be put to use, and for that to happen, everything from the availability of land to , everything needs to be okay. Environmental and non-environmental clearances, government policy and ability of promoters to infuse fair share of capital in projects. And above all, the promoters need to be genuinely interested in completing a project and not in shelling out huge amounts of borrowed money.

While it was going well, nobody cared about these things. Banks were happy to lend. The promoters were happy to borrow. And everyone started living happily. As John Danielson writes The illusion of control: why financial crises happen, and what we can (and can’t) do about it: “Most banking crises are preceded by booms. Everyone takes advantage. Economy is growing. Everyone feels rich. Politicians, policy makers and bankers must be geniuses. The financial system tells us what we want to hear: We’re doing things right, and we’re really smart. Everyone agrees until it goes terribly wrong.”

And that’s how things played out. From 2011 onwards, evidence began to emerge that all was not well. However, the banks either postponed the problem forever or by giving new loans so that earlier loans that were in trouble could be repaid. This, with continued lending at a good pace, increased the outstanding credit-to-GDP ratio to 53.4% ​​by March 2014, and thereafter the ratio started declining.

Since mid-2015, the Reserve Bank of India has started exhorting banks to recognize their bad loans as bad loans and not postpone the problem. In March 2018, bad loans of PSBs peaked 8.96 trillion or 14.6% of their outstanding debt. Since then, the bad loan rate has been falling, and as of March 2022, it stood at 7.3% of outstanding loans, falling to 6.1% by September 2022.

This is due to the recapitalization of these banks by the government by allocating funds in the budget and then issuing recapitalization bonds. In addition, there has also been some recovery of bad loans.

The point is that PSBs are now in the same position as they were around the turn of the century. They have managed to clean up their balance sheets reasonably well and are healthy enough to lend again at a decent pace.

Since 2014-15, the annual growth in outstanding loans of PSBs has always been less than 8%. In the first two quarters of 2022-23, PSBs’ outstanding loans are set to grow by 11.5% and 15%, respectively, the fastest since April to June 2014.

Given these reasons, the temptation to make quick loans without due diligence should still be very high in the 2000s, as it was during the 2000s. Moreover, public sector bankers must be under some pressure from finance ministry bureaucrats to lend to keep long-stalled private sector capital expenditure going.

Therefore, it is worth remembering something that Danielson writes: “The original [of a banking crisis] is usually [in] A stable economy that we view as less risky. Since risk is looked down upon, everyone thinks that borrowing for investment or consumption is a great idea.” Our public sector banks need to ensure that they do not make the same mistakes again.

Vivek Kaul is the author of ‘Bad Money’