What explains rebound in credit growth

What explains rebound in credit growth

Subject: Economy

Context:

With credit growth outpacing deposit growth, credit-deposit ratio has been on the rise.

Details:

• Credit growth to agriculture and allied activities, Industry–large industry and micro-small industries, Services sector, personal loans –witnessed a rise.

What does the above trend indicate?

The  credit-deposit ratio has been on the rise–  reached 73.5% in June 2022 compared to 70.5% a year ago signaling the revival in economic activity and higher investment levels.

Why rise-despite rise in cost of borrowing?--rise in the interest rates on the rise

• The Marginal Efficiency of capital (MEC) is high-MEC is the expected rate of return on capital investment or capital asset, and is a key determinant of investment demand.
  • The marginal efficiency of capital displays the expected rate of return on investment, at a particular given time. Given, reduced consumption demand and inflation will cause reduction in marginal efficiency of capital and thus, the investment demand will decrease causing the growth to slow down.
• The pick-up in credit support comes despite the RBI’s tight monetary policy approach. The central bank has raised the repo rate  leading to a rise in the Marginal Cost of Funds Based Lending Rate (MCLR). 
  • MCLR, a benchmark interest rate, is the minimum fending rate below which a bank is not allowed to lend.

Concept:

Credit Deposit Ratio

• It is the ratio of how much a bank lends out of the deposits it has mobilised. 
• It indicates how much of a bank’s core funds are being used for lending, the main banking activity.
• To calculate the loan-to-deposit ratio, divide a bank’s total amount of loans by the total amount of deposits for the same period.
• The regulator (RBI)  does not stipulate a minimum or maximum level for the ratio. But, a very low ratio indicates banks are not making full use of their resources. And if the ratio is above a certain level, it indicates a pressure on resources.
• Typically, the ideal loan-to-deposit ratio is 80% to 90%. 
• A loan-to-deposit ratio of 100 percent means a bank loaned one dollar to customers for every dollar received in deposits it received.
• A credit-deposit ratio of over 70 percent indicates pressure on resources as they have to set aside funds to maintain a cash reserve ratio of 4.5 per cent and a statutory liquidity ratio of 23 per cent. Under such a scenario Banks can lend out of their capital, but it is not considered prudent to do so.
• The ratio gives the first indication of the health of a bank.
  •  A very high ratio is considered alarming because, in addition to indicating pressure on resources, it may also hint at capital adequacy issues, forcing banks to raise more capital.
  • Moreover, the balance sheet would also be unhealthy with asset-liability mismatches.
  • The loan-to-deposit ratio is used to assess a bank’s liquidity by comparing a bank’s total loans to its total deposits for the same period.
  •  LDR helps to show how well a bank is attracting and retaining customers.
  • The LDR can help investors determine if a bank is managed properly. If the bank isn’t increasing its deposits or its deposits are shrinking, the bank will have less money to lend.