You put a deposit in a bank, and the bank has to invest some of it (21.5%) in government bonds. They can lend the rest to people like you and me.
Except they haven’t.
Even though the government has been paying sub-9% (and now, sub 8%) for borrowing, while you and I pay upwards of 12%, banks have been happy to park much more than required with the government. This is obvious in RBI data, which shows that in the last one year, of all the new money collected, 35% of that has been placed in government bonds!
Effectively, while the RBI is clamouring for banks to cut rates and lend more, banks are keeping lending rates steady and instead, lending more and more money to the government instead.
Banks aren’t lending because they are afraid of more NPAs. That much is obvious now. But is the situation so bad that you will lend to the government at lower and lower yields? Sure, banks saw some profits (because yields fell and prices of bonds went up) but at this point, yields can start to move up, as the US is seeing lately with talks of rate hikes later this year. Then, what comes to the banks rescue? They have to go back to traditional lending, or they will die.
This is the sign of a horrible banking system. We need more banks to provide competition to lending. And we need some of these current banks to improve or fail, the status quo is undesirable. The system is far more stressed than it seems.
Note: You see the dip in that ratio just before this point? That’s the data on 3 April. Banks seem to have had a major effort to look good on their balance sheets, which basically means they lent more (probably evergreened loans) and took on higher deposits just to shore up their numbers. All revealed bank numbers – in their results etc. – are a snapshot as of the last day of the quarter (that is, March 31). Investors would do well to ask banks what their “daily average” deposits and credit numbers were for the month of March, rather than one number on the last day.