Indian banks are stashing cash in safe investments!

Indian banks are stashing cash in safe investments!

Last updated: 31 Jul, 2020 | 02:49 pm

Indian banks are stashing cash in safe investments!

Credit in India is still extremely tight. Every lender in the country is taking an extremely conservative stance.

Banks and lending

  • Central banks of every country (such as RBI in India) use adjustments in borrowing and lending rates to control the money supply in the economy.
  • Interest rates are deliberately lowered to increase the money available with people. As the cost of borrowing decreases, the incentive to borrow increases. Spending also increases as the cost of holding the money is not attractive anymore. This helps spur up inflation and growth in the economy.
  • While the RBI has cut rates, increasing the availability of money in the economy, the effects of these cuts haven’t been felt to a large extent. Despite the moves by RBI, Banks have not been extending credit to the cash strapped economy.

So what are banks doing with the money?

  • Indian lenders are flush with excess liquidity. Their reluctance to take on credit risk has led to them parking their money in highly secured investments like government securities, AAA-rated private and PSU bonds, cash holding with RBI and liquid funds.
  • Private lenders, that have reported earnings for the quarter ended June so far, have shown a sharp jump in their investment books sequentially, while loan books have stagnated. 
  • 'Data shows that investment books (in safe assets) for the 13 private banks that have declared earnings rose over 8.6% between the March and June quarters. That compares to a negative growth of 1.5% in their advances (Lending)'.
  • On an annual basis, advances for this set of banks rose 6.6% year-on-year, while their investment books grew 13.2% over the same period
  • The data above clearly shows the extreme conservatism amongst banks. A sharp deterioration in the economy, however, has left lenders reluctant to lend to most segments. 
  • They are completely unwilling to lend to cash strapped businesses and customers with a low credit score. In actuality, these cash strapped companies are the ones that actually require a liquidity injection. RBI did help SME’s and MSME’s with credit free loans through banks. However, that has still not been very effective. A much stronger measure is required by our central bank.

The graph below shows the weakness in credit growth.

  • The shift towards bonds is also partly driven by the Reserve Bank of India’s decision to introduce long-term repo operations. Under LTRO, RBI provides longer-term (one- to three-year) loans to banks at the current repo rate (4% currently). As banks get long-term funds at lower rates, their cost of funds falls. In turn, they reduce interest rates for borrowers. RBI uses this tool to inject liquidity in the system and to ensure transmission of rates.
  • Under the LTRO and targeted LTROs, the RBI has provided banks with long term funds, some of which are mandated to be directed towards purchasing corporate bonds. Thus, RBI has given a direct incentive for banks to invest in corporate and government bonds. 

“As of July 3, total SLR investments (liquid assets like Govt securities) as a percentage of total assets stood at 28% against the regulatory mandate of 18%”.

INDmoney Analysis

  • Considering the current economic environment it is understandable as to why banks are taking a conservative approach. Risk of high NPA’s is very serious. However, for the country as a whole, this is adding pressure to the already strenuous situation.
  • The conservative nature is expected to continue in the short term. The high demand for government and AAA-rated bonds is the primary reason in their rally since the announcement of lockdown. The demand for these securities will remain high.
  • AAA-rated and government securities have outperformed every other category of fixed income securities and will continue to do so in this volatile economic environment. Therefore stick to only AAA bonds and debt funds.

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