RBI steps up liquidity support amid government credit push

The Reserve Bank of India has unveiled new liquidity measures to support a government push to encourage banks to lend to the non-bank financial sector.

Though the measures may help support India’s sagging growth rate, they could also impact the RBI’s attempts to clean up the banking sector.

As part of the new government’s budget, published on July 5, the fiscal authority is extending a credit guarantee to public sector banks that lend to non-bank financial firms that are deemed creditworthy. For lending of up to a trillion rupees ($14.6 billion), the government agrees to cover the first 10% of any losses.

In support of this initiative, the RBI says it is fast-tracking changes to banks’ liquidity rules, which should free up extra funds. Banks will now be able to count an additional 1% of their net deposits and time liabilities held at the RBI towards their liquidity coverage ratio. This should allow banks to use any excess funds for lending.

The RBI stresses it has been adding liquidity to the system for the past six months. It says the system has been in surplus for over a month.

The central bank first stepped in with additional liquidity injections amid turbulence in the non-bank financial sector in mid-2018, after a major firm defaulted, triggering fears over possible contagion.

Meanwhile, it has been a priority of the government under prime minister Narendra Modi to boost credit to the real economy, in a bid to resist a recent growth slowdown. In the budget, the government highlighted how non-banks play an “extremely important role in sustaining consumption demand” as well as financing investment by small businesses.

While the government said its guarantee would only extend to “high-rated pooled assets of financially sound” non-bank firms, the measure could clash with recent efforts by the RBI to clean up the banking sector. Public sector banks are the most encumbered by non-performing loans.

The central bank’s latest financial stability report notes the financial sector appears to be recovering, with balance sheets looking stronger in both the bank and non-bank sectors. However, public sector banks suffer from higher rates of non-performing assets and lower credit growth than private banks, the report says.

The RBI is still agitating for change. A revised circular, published in June, revamped the central bank’s approach to tackling stressed assets after the Supreme Court struck down an earlier version.

RBI governor Shaktikanta Das has stressed the need for discipline among public sector banks, so they can attract private funds, rather than having to rely on the government for support.

But there is little sign of government support abating. In October 2017, the government injected $32 billion to recapitalise the state-owned banks and the latest budget measures include a further $10 billion injection for the same institutions.