The bank credit flow to commercial sector in India has been facing challenge with the non-bank source of credit now far exceeding bank loans, according to RBI statistics (refer chart) available on this.
While the share of bank loans in credit to the commercial sector was around 56 per cent in 2011, and that of non-bank sources of credit (commercial paper, corporate bonds and external commercial borrowings) at 44 per cent, in just six years, the trend has taken a U-turn.
By 2017 September, the role of bank intermediation in corporate credit has taken a beating, giving way to non-bank finance, especially the fixed income mutual funds. Currently, the banks’ contribution to corporate credit stands at around 38 per cent and that of non-bank sources at 62 per cent.
A recent study by R. Ayyappan Nair, M V Moghe and Yaswant Bitra – all working (refer chart) with different departments of Reserve Bank of India (RBI), points to a key finding that the significant increase in inflows into mutual funds and their subsequent deployment is altering the scope of disintermediation in India’s huge credit market.
They have found that there has been a gradual shift in corporate borrowings from banks to mutual funds as reflected in the contraction in corporate spreads for near-investment grades; and a significant differential between the risk-free rate and the benchmark lending rate for banks – the marginal cost of funds based lending rate (MCLR), which has thus given rise to the disintermediation of bank credit for quality corporates with better rating.
According to the study on the new trend, the flow of liquidity into debt-oriented mutual funds has given rise to a swelling of money market mutual fund (MMMF) corpus.
According to the researchers, the rise of bank disintermediation in corporate credit does enable our financial system to become robust and more efficient in allocating risks. They point out that the unintended consequence of this process could potentially force banks, concerned with the shift in higher-rated borrowers to mutual funds, to either lower their credit standards or to engage in pricing that does not truly reflect their cost of funds.
If banks lower their credit standards, the impact of such “adverse selection” may add to further disintermediation and an increase in the expected losses of credit portfolio of banks. On the other hand, pricing pressure may also force banks to ration the credit and lend only to the high-rated borrowers even at the cost of imperfect pricing.
Both could potentially result in a failure to properly allocate funds in the loan market. “In the absence of a well-capitalized banking system, the ability of banks to compete with mutual funds and other market intermediaries through reduction in intermediation cost is limited. This may not only hamper credit growth but also further weaken the risk culture in banks” they said.
Therefore, undertaking necessary structural reforms to restore a healthy banking sector is of paramount importance. At the same time, structural reforms supporting the corporate bond market such as the Insolvency and Bankruptcy Code (IBC) are likely to give a further fillip to non-bank finance for Indian borrowers.