While Rajan’s initiatives to cut bad loans has started yielding results, banks have been scared out of lending which has taken credit growth down to a two-year low.
The next Reserve Bank of India governor faces a tricky task completing a bank clean-up spearheaded by outgoing Governor Raghuram Rajan, while coping with the demands of a government that is desperate to see a revival in lending to businesses.
Rajan was feted by investors for his efforts to deal with a mountain of bad debt clogging India’s financial system, but his critics say an excessive focus on asset quality has scared banks out of lending and is partly to blame for credit growth slumping to a near two-decade low.
“The bad thing is that funding by banks has almost stopped. There’s too much negativity. The government may not want it to precipitate more,” said a senior banker, adding it would be hard for the new governor to push balance sheet reform much further.
Senior officials have told Reuters the government has narrowed down to four its list of candidates to replace Rajan, who stunned markets when he announced on June 18 he would not seek reappointment in September.
Rajan, a former International Monetary Fund chief economist, has spoken out against India’s “crony capitalism”, which has seen banks endlessly rolling over dud loans to companies, and insisted lenders fully reveal the extent of bad assets and undertake “deep surgery” to deal with them by March 2017.
A review of banks’ asset quality by the Reserve Bank of India (RBI) has brought to light roughly $35 billion (nearly Rs 2.32 lakh crore) of new bad loans since September.
As the clean-up has taken hold, loan growth slipped to 10.7% in the last fiscal year to the end of March, the slowest in almost 20 years.
The risk is that clamping down too hard on lending crimps economic growth, stoking a vicious cycle of more defaults and lower business investment and production.
Finance Minister Arun Jaitley said in a recent television interview with the Zee Media network that banks should strike a balance between expanding credit and cutting non-performing assets, warning them not to stop lending as a “panic reaction”.