Banking on deposit growth to drive credit

The banking sector is the cog that will drive the actualisation of ‘Viksit Bharat’ by 2047. While heavy lifting by the government has helped improve investments in the past many years, it’s efforts to rein in the fiscal deficit and a sluggish economy mean the time has come for the private sector to show hand.

In terms of financial strength, the sector is better off after a long bout of deleveraging of balance sheets that, in turn,has created headroom for bank credit to expand.

Today, median gearing is at less than 0.5 time and capex intensity is moderate, averaging 50% over fiscals 2024 and 2025 against a decadal high of 72% in fiscal 2016.Hence, the stage is set for higher industrial credit.

To be sure, bank credit growth is moderating as a balance is being sought between credit and deposit growth,and to accommodate macro-prudential measures. The upshot would be a gradual increase.
Sufficient capital cushion and improved asset quality— the gross non-performing assets (GNPA) ratio was 2.6% of gross advances as of September 2024 — will support growth in credit.

Banks are expected to post an 11-12% increase in advances during the current fiscal, against 16% yearago. The advances of non-banking financial companies/housing finance companies (NBFCs/HFCs)will likely increase 16-17% this fiscal, against ~20% last fiscal. 

Given the milieu, banks and NBFCs/HFCs expect the government to introduce the following measures in the Union Budget for fiscal 2025 to ensure growth momentum continues: 

1.    Enhance the financial inclusion of MSMEs through credit expansion: With manufacturing poised to be a key driver of economic growth, private capex is expected to play a vital role. This makes funding tomicro, small and medium enterprises (MSMEs) through banks and non-banks a priority. Stakeholders suggest the government: 

o    Increase the priority sector lending (PSL) limits of banks for on-lending to NBFCsto enableMSMEs to get funds at a lower cost.At present, the on-lending cap is 5% of average PSL achievement in the four quarters of the previous fiscal
o    Give concessional export financing for MSMEs and impose import duties to create a favourable environment

2.    Boost the green financing space to support India’s 2030 renewable energy target:India’saimto generate 500 GW from renewable energy sources by the decade’s endis aimed at getting the country closer to its net-zero vision. Green financing incentives for banks will help achievethis milestone. At present, up to Rs 30 crore funding by banks for solar-based power generators, biomass-based power generators, windmills, micro-hydel plants and for non-conventional energy-based public utilities, among others, is classified under PSL.

A higher PSL limit would incentivise banks to increase lending to this space.In the budget, the government can: 

o    Promote partnerships between banks, non-banks and development financial institutionsto encourage green funding, as power projects entail significant investment and a long gestation period. Further adequate equity funding can be ensured through the presence of robust capital markets, infrastructure investment trusts, and the strategic secondary sale of operational assets.
o    Give tax incentives for investments in green bonds to draw in investors, and ease green financing disclosure norms for financial institutions and corporates
o    Provide accessible financing for MSMEs to adopt green solutions, such as solar rooftops, to reduce operational costs
o    Tax incentives for retail individual investments in infrastructure and green bonds, specifically issued to support the development of renewable energy infrastructure projects. Currently, the Income Tax Act offers tax deduction of maximum Rs. 20,000 for investments in government-specified long term infrastructure bonds with minimum lock in of five years.

3.    Improve deposit mobilisationand liquidity: The savings landscape in India has undergone a significant transformation over the past few years. Soaring inflation has diminished the allure of traditional deposits, driving households to investment avenues that promise more attractive returns, such as capital markets, real estate and gold.

Meanwhile, credit growth outpacing deposit growth has raised concerns among regulators, highlighting the need for a more sustainable funding model. The government needs to prioritise the development of a robust retail liability franchise for banks to revitalisesluggish deposit growth and mitigate potential liquidity risks. The government can:

o    Lower tax rates on fixed deposits and align them with capital gains taxationto increase the fundsflow to the banking system
o    Give incentives in the form of a lower lock-in period on fixed deposits to claim deductions under Section 80C of the Income Tax Act

4.    Strengthen the collection mechanism for banks: Strategic intervention has played a crucial role in reducing the non-performing assets (NPAs) of scheduled commercial banks. Asset quality has improved significantly with GNPAsshrinking from 8.4% of gross advances in fiscal 2018 to 2.6% in September 2024. This demonstrates the effectiveness of measures such as the Insolvency and Bankruptcy Code, amendments to the SARFAESI Act and the Prudential Framework for Resolution of Stressed Assets.Moreover, the government had offered guarantees worth Rs 30,600 crore to the National Asset Reconstruction Company Ltd (NARCL), established in July 2021, for acquiring stressed assets.To further enhance recovery mechanisms, the government should:

o    Establisha robust monitoring mechanism for cases in the NARCLand the National Company Law Tribunalto identify and address procedural delays and adjournments in real time 
o    Shorten recovery times by reducing the limit of Rs20 lakh with NBFCs to invoke provisions of the SARFAESI Act 
o    Improve recovery rates and to reduce delays for written-off loans by strengthening the Insolvency and Bankruptcy Code 

5.    Reduce the dependence of NBFCs on bank funding: To reduce concentration of liability franchise of NBFCs/ HFCs and promote diversification, the government can look to:
o    Offer NBFCs regulatory support to access alternative funding avenues, such as capital markets, financial institutionsand overseas borrowings
o    Reform the refinancing window with less stringent provisions for NBFCs to on-lend to MSMEs and priority sector categories

6.    Enhancecredit flow to agriculture: To improve financial inclusion in the agricultural sector, the banking industry would like the government to:
o    Implement new technologies, such as the Unified Lending Interface, to provide loans with minimal documentationto farmers
o    Enhance credit limits for agricultural loans via Kisan Credit Cards — which has provided timely and hassle-free credit to farmers — to increase credit demand in the agriculture sector
o    Focus on improving credit flow to farmers and reduce their dependence on informal credit channels
These measures would go a long way in helping the banking sector enhance financial stability and spur growth, continuing to play a pivotal role in India’s economic development.