Bank NPAs weaken monetary policy transmission, lower loan growth rate, says RBI paper

The presence of non-performing assets (NPAs) in banks hinder monetary policy transmission and affects bank lending growth, according to a working paper released by RBI officials titled Bank Capital and Monetary Policy Transmission in India. “Presence of non-performing assets in a bank also weakens monetary policy transmission and lowers the loan growth rate,” the paper said stressing that the views expressed in it are those of authors and not of RBI. Authored by Silu Muduli and Harendra Behera of the Department of Economic and Policy Research (DEPR) at RBI, the paper also underscored the need for capital injection by the government into public sector banks that may increase the credit flow to the real sector along with the smoothening transmission of monetary policy.

According to study findings, there is a positive association between bank equity and credit growth that “calls for the need for a countercyclical capital buffer for the banks to protect their balance sheet against losses from changes in economic conditions during the recessionary phase.” Also, banks with higher Capital to Risk (Weighted) Assets Ratio (CRAR) see a lower cost of funds. Hence, a higher CRAR “unlocks the bank lending channel and helps in smooth transmission of monetary policy,” the paper noted. On the other hand, Lower CRAR obstructs the smooth transmission of monetary policy and not just impacts a bank’s health. Nonetheless, the magnitude of transmission of monetary policy emerged weak for banks with CRAR higher than a certain threshold level, it added.

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Bank NPAs are likely to grow to double digits this year due to multiple challenges including Covid led disruptions. The country’s NPA ratio is among the highest vis-à-vis comparable countries and is likely to reach 11-11.5 per cent by FY21 end, according to a report by Care Ratings. Lower-rated corporates ineligible for the restructuring scheme already stressed companies that could face liquidity constraints in a challenging economy, along with banking exposure to unsecured personal loans, are other reasons for higher bank NPAs this fiscal.