A V Rajwade: Bank credit and capital

Considering the amount of money the banking sector would require, one solution could be greater openness to foreign banks.

ICICI Bank's equity issue for adding Rs 20,000 crore to its capital has been in the news in recent weeks. The first response from the equity market has been somewhat negative, with softening of the bank's share price. In this background, this article looks at the likely credit growth and the capital the Indian banking system would need to raise over the current and next two years, on certain robust assumptions.

ICICI Bank CEO K V Kamath has stated that, typically, the banking sector grows (in nominal terms?) three times faster than the economy (in real terms?). I have considered the numbers from a different perspective. The starting point is the likely growth in nominal GDP. This has been assumed to be 13 per cent p.a., in alignment with the numbers in the Budget. On the further assumption that the gross fiscal deficit of the states and the central government together would be limited to 6 per cent of GDP, the nominal GDP number has been translated into gross fiscal deficit and the issue of government securities for market borrowings. In the table, the proportion assumed to be funded by market borrowings has been kept constant at 53 per cent, as in fiscal 2006-07. Actually, over the years, the proportion of gross fiscal deficit financed through market borrowings has been growing, a point I come to a little later. 
 

CREDIT LINES All figures except % are in Rs '000 crore
		2005-06	2006-07	2007-08	2008-09	2009-10
(1)	Nominal GDP	3531	4061	4589	5186	5860
(2)	Gross Fiscal Deficit (of Central + State Governments)	261	260	275	311	352
(3)	Part of combined Fiscal Deficit funded by market borrowings	118	137	146	165	186
(4)	Part of market borrowings funded by Banking Sector	71	82	87	99	111
(5)	Aggregate Deposits Growth Rate		23%	23%	23%	23%
(6)	Aggregate Deposits	2109	2594	3191	3925	4828
(7)	NDTL	2306	2837	3489	4292	5279
(8)	SLR Holding(previous yr+ (4))	722	804	891	990	1101
(9)	SLR as % of NDTL	31.30%	28.30%	25.50%	23.10%	20.90%
(10)	CRR	5%	6%	5%	4%	3%
(11)	BANK CREDIT	1496	1923	2416	3141	4056
(12)	BANK CREDIT growth		28.50%	26%	30%	29%
(13)	Risk Weighted Assets (RWA)	1797	2315	2908	3781	4882
(14)	Capital ratio	12.30%	11%	10%	10%	10%
(15)	Capital Funds needed	221	255	291	378	488
Notes: 1. All values for 2005-06 & 2006-07 are actuals (except Capital Funds and CAR for 2006-07 which are estimates). 2. All figures for subsequent years are estimated - e.g. Bank Credit is calculated as (Aggregate Deposits + Capital Funds - SLR Holding - CRR.) 3. The ratios of Aggregate Deposits/NDTL and Bank Credit/RWA have been assumed as constant. 4. Market borrowing figure is net borrowings.

The tabulated numbers estimate growth in bank credit, based on a deposit growth rate of 23 per cent, the same as last year, but ignoring other demand and time liabilities. One assumption underlying the projections is that the proportion of market borrowings funded by the banking sector remains unchanged at about 60 per cent; this proportion may well come down as more investors""insurance companies, pension and provident funds etc.""invest in government securities, and broadly compensate for the increase in the proportion of fiscal deficit financed by market borrowings. As the table shows, only about an average of Rs 100,000 crore a year of SLR securities would be available for investment by the banking system; one also expects that the cash reserve ratio would gradually come down to 3 per cent by the end of March 2010.

On these assumptions, projections in the table suggest that the statutory liquidity ratio may need to drop below 20 per cent (18 per cent?), given the available incremental SLR securities, if deposit growth continues at 23 per cent. (The SLR will have to drop even more if the RBI wants to replenish its holdings of government securities.) With a lower SLR and CRR, the supply of bank credit would increase from Rs 19 lakh crore at the end of the last fiscal year, to Rs 42 lakh crore at the end of March 2010. This translates into credit growth of nearly 30 per cent p.a., a number the RBI is uncomfortable with. In the last monetary policy statement, the targeted number has been indicated at 25 per cent. If this is to be met, arithmetically, there are only three options""slower deposit growth (what of inclusive banking then?); higher fiscal deficit; or a higher cash reserve ratio.

What about the demand side for credit? A recent CRISIL report has estimated the concretised investment plans of specified industrial sectors at Rs 8 lakh crore. ICICI Bank has talked of $500 bn (Rs 20.5 lakh crore) of corporate investments in the next few years. A third perspective is infrastructure investment of $350 bn over the 11th Plan, of which 50 per cent may need to come from private sector investments.

All these numbers are for capital expenditures. The banking system's core function is the provision of working capital finance, and this too will need a substantial expansion of credit as industrial growth continues in double digits. Add to this the need to increase credit flow to the rural sector including micro-finance and agriculture. Housing and real estate is another sector requiring large funds. Overall, from the demand side, a Rs 23 lakh crore increase in bank lending over three years does not look unrealistic. And, even then bank credit in India would be barely 70 per cent of nominal GDP in 2009-10""in comparison, the corresponding number for Malaysia is 120 per cent, Korea 143 per cent and even higher for China. (Incidentally, Vietnamese bank deposits tripled in 5 years to 2006!)

The other side of the equation is that the banking system would need to add more than Rs 2 lakh crore in this and next two years, even at a (lower than current) capital ratio of 10 per cent, by way of both plough-back of profits and infusion of fresh capital. A daunting task by any standards! (Incidentally, the system added just over Rs 1 lakh crore of capital in the three years to March 31, 2006.) One solution: much more openness to foreign banks?

avrajwade@gmail.com