Banking reforms need to get a lot more ambitious for the economy’s sake

Under the present system of a single nominee, couples tend to nominate each other; should they both pass away together, say, in a road accident, their heirs would have a tough time accessing their inheritance. Instituting multiple nominees would significantly reduce the number of orphan accounts and the monies held in them.

While these changes are welcome, they do not address India’s principal challenge of banking. Bank credit to the commercial sector in India has hovered around 50% of GDP. This is far below the figure for most developed countries and also China, where bank loans exceed the economy’s annual output.

The only rich country where bank credit is a low proportion of GDP, like India, is the US. But then, America has a well-developed debt market that lets companies borrow from individual investors and saving pools, regardless of whether lending them money is deemed safe or very risky.

Rated highly or as ‘junk,’ bonds issued by businesses tend to find takers in the US.

A 2022 report by the Lok Sabha Standing Committee on Finance put the unmet credit demand by micro, small and medium enterprises (MSMEs) at ₹25 trillion or 47% of their borrowing needs.

While more than 90% of India’s nearly 60 million MSMEs are micro sized and best served by specialized non-bank finance companies (NBFCs) that have the wherewithal for this task—which involves high processing costs loaded onto small loans—our banks must play their role, too, by lending money to NBFCs for them to lend tiny enterprises.

While this has been happening to some extent, MSME associations still complain that barely 15% of their credit requirements are met from banks.

Recently, the Reserve Bank of India (RBI) cracked down on some NBFCs that were allegedly making usurious loans. This was partly on the suspicion that an unhealthy chunk of retail loans were being used by borrowers to speculate on the stock market. The banking sector’s regulator is right to be concerned about that, but wrong to curtail additional lending by NBFCs.

After all, a tiny enterprise that’s denied access to an NBFC would probably turn to an informal money-lender who will charge rates of interest many times higher than what even credit-card issuers do, which are typically higher than the rates RBI terms ‘usurious’ when levied by NBFCs.

India’s credit market needs a structural shift. Large well-known companies must raise funds, especially project finance, by issuing bonds instead of borrowing from banks. Large clients lull banks into lazy banking; their funds get deployed relatively safely and profitably, and they’re spared the job of doing risk assessments for relatively small loans.

Since risk pricing is the core role that banks are expected to play as financial intermediaries in an economy, such laziness must end. India’s Account Aggregator framework lets banks collate financial data on small borrowers and assess risks in a way that wasn’t possible a decade ago.

Banks should take on larger MSMEs as clients and invest in bonds issued by NBFCs that lend to tiny enterprises. Since they would be able to charge higher rates of interest than on loans to large corporations, it would help their bottom-lines too.