The Banking Sector: Credit Growth at a Dead End

It is commonplace that banks are a proxy for the economy. When the economy does poorly, one would expect banks to do poorly, since their main activity is intermediating funds between lenders and borrowers, and it is harder to find good borrowers when the economy is stalling. 

With India’s 2QFY2025 GDP growth rate sharply decelerating to 5.4% (8.1% in 2QFY2024), what will sustain non-food credit growth? The State Bank of India (SBI) chairman says that the GDP slowdown was a “blip”, and that, while some segments such as personal loans have fallen off, the State Bank of India’s (SBI’s) credit in agriculture, small and medium enterprises (SME) and corporate have “grown well”. Irrespective of such boilerplate statements, the question of where credit growth will come from must be uppermost on the minds of bank CEOs.  

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Non-food credit (NFC) growth (excluding impact of HDFC Bank merger with HDFC) has been steadily slowing to 12.8% yoy as on October 18, 2024, from the 15.5% yoy on October 20, 2023. In both the pre and post COVID periods, non-food credit growth has not been stellar. In September 2019, NFC growth rate had slumped to 8% yoy, indicating an economic slowdown even prior to COVID. In the wake of the COVID slump, NFC growth was 16.9%-15.4% yoy in the period September 2022 to March 2023. Thereafter the growth has come down to 14.4% in September 2024 and slumped to 12.8% by October 18, 2024.

Components of Non-Food Credit Growth

The critical drivers of NFC growth in the recent period have been retail and, to a lesser extent, services. This has resulted in a shift in the pattern of credit. In September 2019, before COVID, retail constituted 27.3% of NFC; this increased to 31.4% by September 2024. Meanwhile, services went up from 27.4% to 28.5% in the same period.

The retail driver has increasingly come under pressure as the regulator, the Reserve Bank of India (RBI), has been cautioning Non-bank Finance Companies (NBFCs), Micro Finance Institutions (MFIs) and Housing Finance Companies (HFCs) against aggressive lending. The RBI has also warned  lenders regarding lending to unsecured retail customers, as retail stress is building up in the economy. As a result banks have sharply slowed lending to NBFCs, MFIs and unsecured retail borrowers. 

On the face of it, the industrial credit growth rate indicates a revival, especially as credit to large companies is increasing. The central issue is whether the growth rate in industrial credit is sustainable, and whether it can compensate for the decline in the retail credit growth rate. 

The spurt in industrial credit is on account of a low base and a secular decline in the share of NFC since March 2008. The graph is a stark reminder of the state of industry in India in the past 15 years.

In September 2019, industrial credit’s share of NFC was 32.2%; despite the recent pick-up in its growth rate by September 2024, its share was only 22.8% (excluding the HDFC merger). Therefore while the industry credit growth is at present showing some revival, it is on the back of a lengthy period of shrinking as a percentage of NFC.

Industry Credit September 2019 and September 2024

Worryingly, the share of large companies as a proportion of NFC has come down sharply in the same period while there has been an improvement in credit to micro, small and medium companies.

RBI data on the sources of funds of companies reveal that in 1HFY2025, companies reduced their long term borrowing while at the same increasing their short-term borrowing as compared with both 2HFY2024 and 1HFY2024. The deployment of funds by the companies shows an increase in receivables and financial investments with no major increase in fixed assets. That companies are willing to deploy more funds in financial investments rather than fixed assets indicates their view on future demand for their products. The increase in short term borrowing has thus been deployed in working capital and investments. It is possible that with demand growth weakening as reflected in corporate sales, receivables are increasing and corporates are requiring additional short term bank borrowings to finance the rise in receivables. 

A CMIE sample of 3,359 companies also reveals a higher percentage growth in current assets as compared with fixed assets and income in non-financial companies in 2QFY2025. Thus, the data suggests that even a slight spurt in industrial credit may be deployed to finance higher receivables, not a healthy sign when there is a demand problem.

The improvement in credit to the SME sector may be on account of the government offering a guarantee on some of these loans, as the sector is undergoing acute distress. Reports suggest that 48% of SMEs have shut down in the last eight years on account of demonetisation and the implementation of the Goods and Services Tax (GST). The credit growth for the SME sector may be for their survival, not growth.

When a sector is under severe stress it is unlikely that commercial banks will increase exposure without a guarantee from the government. It is also unlikely that industrial credit, which is showing some revival, albeit on a low base, can compensate for the shrinking contribution of retail credit. In the 2QFY2025 GDP, manufacturing grew by only 2.2% yoy.  The depressed manufacturing growth rate, the long stagnation in industrial credit and the weakening corporate sales growth are signs that the corporate sector is going through a lean period, without any clear route to revival.

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Within retail credit, housing credit (15% of NFC in September 2024) continues to grow, but for most banks, it is a low margin product and it is remunerative for those banks who have low cost of funds or venture into higher-risk housing loans.

With the economy showing weakening demand, the RBI cautioning against loans to sectors which recently were drivers of overall NFC, and quality stress rising in unsecured loans and retail, credit growth for banks appears to be at a dead end, especially for large banks. All banks may focus on the premium retail segments for growth which is a limited space and which cannot drive overall bank credit. 

Hemindra Kishen Hazari is a Securities and Exchange Board of India (SEBI)-registered independent research analyst.