We will explore three key data points that reveal why RBI is cautious about rapid credit growth.

The story

India is hungry for credit, but there’s a gap between demand and supply. Banks are lending aggressively, capturing the opportunity. However, the RBI is raising concerns as the rapid credit expansion comes with its own problems.

There are two ways any private entity can raise capital. One is by giving away its equity and the other is debt, i.e. by taking credit.

Access to loans is critical for growth for businesses and individuals alike, particularly for unorganized businesses and sectors, where raising capital via equity is difficult.

Exhibit 1:

The key highlight:

  • Compared to other countries, India’s credit to the private sector is surprisingly low—just 54.7% of GDP as of 2021.

The result? A credit gap—the shortfall between credit demand and supply.

According to a report by Avendus Capital, Indian Micro Small & Medium Enterprises (MSMEs) alone face a credit gap of $530 billion.

To fix this, the government launched formalization efforts, helping businesses follow legal rules and join the organized economy.

This also made it easier for banks to lend, boosting credit expansion.

The key highlight:

  • Banks have been lending at a much faster rate than they’re receiving deposits.

Indian banks are lending more aggressively to meet the growing demand for credit. But banks could only offer loans if they’re getting sufficient deposits.

The misaligned growth of loans and deposits forces commercial banks to align loan growth more closely with deposit growth. It brings in the problem of rising Non-Performing Assets (NPAs).

Exhibit 3:

The key highlight:

  • After 2018, NPAs have continuously declined, indicating an improving health of the banking sector.

NPA (Non-Performing Asset) refers to a ‘bad loan’ for banks, where the borrower has stopped repaying loan amount and interest for 90 days or more, signaling a default risk for the lender.

The recent surge in credit could bring back similar challenges if not handled carefully.

To conclude

India’s growing credit gap signals a strong demand for growth and investments.

It’s important to monitor credit growth closely, especially to avoid a surge in NPAs. Proactive measures by banks and the RBI can ensure stability and create a positive outlook for sustained development.