Under-capitalised banks can hurt real economy: Economic Survey
Jan 29, 2021
New Delhi [India], January 29 : The Economic Survey 2021 released on Friday has called for adequate capitalisation of public sector banks and strengthening the legal infrastructure for recovery of loans.
It said sound governance is a key metric to ensure that banks do not engage in distortionary lending post capital infusion. The regulator may consider penalties on bank auditors if ever-greening is discovered as part of a toolkit of ex-ante measures.
This will create incentives for the auditor to conduct financial oversight more diligently, said the survey.
On the other hand, lenders may resort to risk-shifting if capital is not provided. In turn, impacting the real economic recovery.
"Under-capitalised banks may again resort to risk-shifting and zombie lending, thereby severely exacerbating the problem," said the survey.
"The adverse impact could then spill over to the real economy through good borrowers and projects being denied credit. The resultant drop in the investment rate of the economy could then lead to the slowdown of economic growth," it added.
Public sector banks account for 60 per cent of the assets in Indian banking system. These banks also account for over 90 per cent of stressed assets in the system.
The survey said inadequate capitalisation of banks can have a serious impact on real economy as credit flow dries up to productive sectors.
In an already-stressed banking sector, the second wave of under-capitalisation caused by the asset quality review (AQR) created perverse incentives to lend even more to the unproductive zombie borrowers, it said.
It said there was a significant increase in the value of stalled projects following the AQR for firms exposed to banks affected by the AQR when compared to firms that engaged with unaffected banks.
"These firms became financially constrained and reduced their capital expenditures, leading to ongoing projects being stalled," said the survey.
"In terms of lending, banks being undercapitalised reduced lending to good borrowers while increasing lending to zombie borrowers. For firms, the reduction in supply of bank credit reduced their ability to invest," it said.
