Why Credit Transmission in India Lags ?

We are living in a paradox and COVID-19 has just compounded it. On one hand, we read that the stock market is at an all-time high, and billions are getting pumped into the startup ecosystem as equity, blockbuster IPOs, and so on. On the other hand, we have severely vulnerable, credit-starved SMEs.

The financial gap is Brobdingnagian for these micro, small and medium enterprises (MSMEs). Less than 20% of them have access to formal credit. And things are no different at an individual level. Of the 400.7 million-strong working population, only 200 million are credit-active.

Given that penetration of credit is a proven harbinger of economic growth, I wanted to analyse what plays a constraining influence on it.

The Underlying Cause

In India, the channel of monetary transmission primarily exists in the form of banks and shadow banks (NBFCs). And the regulator, RBI, has done an excellent job of widening it by periodically introducing new licences such as SFB, Payments Bank, P2P NBFC, etc.

However, the efficacy of these channels has been a challenge, owing mostly to operational standards that have resulted in poor asset quality.

Source: RBI

The Ripple Effect

The deterioration in asset quality and weak bank balance sheets have been at the root of decelerating credit growth since 2013. And, because credit and economic activity have a symbiotic relationship, it has had a direct impact on growth.

To reverse engineer this trend and get the economic engine humming again, we need to address the fundamental problem of credit transmission. The basic, obvious and first step, RBI posits, is to strengthen the bank system’s balance sheet by resolving the asset quality, i.e., bad debt.

But isn’t it akin to treating the symptoms and not the root cause? Shouldn’t it be more necessary to identify the origins of bad debt and take drastic measures to address them? But that’s a story for another day.

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