How demonetisation crippled bank lending

It is, of course, well known that the growth of bank credit slowed in the second half of 2016-17 due to demonetisation. Reserve Bank of India (RBI) data shows that as on 30 September 2016, the annual rate of growth of bank credit was 12.1%. That year-on-year growth rate decelerated sharply to 5.4% by 31 March 2017. It indicates the banking system is yet to recover from the after-effects of the note ban.

More interesting, though, is the question about which parts of the nation bore the brunt of the lending slowdown resulting from demonetisation. RBI data show that lending to rural India was badly affected. Growth in rural loans between 30 September 2016 and 31 March 2017 was a mere 2.5%. Compare that with the growth of 12.9% in the second half of 2015-16 and the extent of the slowdown becomes clear (chart 1).

There is little doubt that the note ban hurt rural India and that, as at end-March, loan growth was far below its pre-demonetisation levels.

Indeed, in the second half of FY2017, bank lending to rural Haryana, Punjab, Goa, Maharashtra and Kerala contracted. Lending to rural Maharashtra fell by as much as 9.2%. Putting that in perspective, bank loans in the second half of FY16 to rural Haryana increased by 18% and to rural Punjab by 12.2%, while rural Maharashtra saw an increase in lending of 5.8%. Not a single state had showed a contraction in rural lending in the second half of FY16. In other words, the slowdown in rural lending in the second half of FY17 was very abnormal and may be attributed largely to demonetisation.

How much of this deterioration in rural lending was due to the public sector banks? Many nationalized banks are in no position to lend, saddled as they are with bad loans. In fact, nationalized banks saw their lending to rural India grow by a mere 0.5% in the second half of FY17.

A year ago, in the second half of FY16, nationalized banks had increased their lending to rural India by 13.3%. The sharp deceleration in rural lending by public sector banks is bad news for the remoter parts of rural India, as it is the public sector banks which take care of the credit needs of these places. Lending by State Bank of India and its associates to rural India during the second half of FY17 too grew by a mere 0.6%. Chart 2 has the details.

But it isn’t true that private sector bank credit to rural India was unaffected. True, private sector banks saw their rural credit rise by a decent 14.6% in the second half of FY17. But this was on a low base, compared to the public sector banks. What’s more, private sector bank credit to rural India had gone up by as much as 28.4% in the second half of FY16. In other words, growth in private sector bank credit to rural India halved after demonetisation. While it is true that bank credit in India was limping even before demonetisation, the note ban crippled it.

Lending to rural India was the most affected, but other parts of the country also saw a deceleration in credit growth. In the second half of FY16, growth in bank credit to semi-urban India, urban India and metropolitan India was 11.9%, 11.2% and 12.3% respectively. In the second half of FY17, growth had slowed to 6.4%, 6.1% and 5.5% for bank lending to semi-urban, urban and metropolitan India respectively. Overall bank credit growth in the second half of FY17 fell to 5.4%, less than half the 12.2% rate of growth for the second half of FY16.

Which group of banks was the most affected? Nationalized banks’ credit growth was 2.7% in the FY17 second half, compared to 8.8% growth in second half FY16. SBI and its associates saw their credit growth fall to 7.8% in the second half of FY17 compared to 13.7% in the second half of the previous year. Private banks’ credit growth was 10.1% in the second half of FY17 compared to 18.8% in the year-ago period. Clearly, every category of banks was affected.

Which regions were the most affected? The rural parts of western India bore the brunt, with credit growth falling by 5.1% in the second half of FY17. Rural northern India and metropolitan western India also saw very low credit growth.

As the economy is remonetized, bank lending should pick up. The pace at which that will happen depends on whether the introduction of the GST leads to a fresh round of disruption. Far more important is the need for a solution to the bad loan burden of banks, which is necessary to encourage further lending, particularly for the nationalized banks.