Why Banks in India Are Lending Less: RBI’s Money Creation and Bank Profits Explained
The decline in loan-to-deposit ratios (LDR) in India’s banking system has been attributed to two main factors: lower money creation by the Reserve Bank of India (RBI) and higher bank profits over the past two years.
Lower Money Creation by RBI
In the fiscal year 2023-24, the RBI’s net money creation was only Rs 0.6 trillion, a significant drop from the approximately Rs 20 trillion created in the three fiscal years before (FY20-22). This lower money supply has limited banks’ ability to expand their lending relative to deposits.
Higher Bank Profits
Another factor is the substantial increase in bank profits. In FY24, banks’ total profit was 1.8% of the previous year’s deposits, up from an average of 0.1% between FY16-20. While this indicates strong financial performance, it has led to a reduction in deposits as banks appropriate a larger portion of these profits.
Impact on LDR
The elevated LDR should be viewed as a cyclical phenomenon rather than a systemic issue. The lower money creation by the RBI and higher bank profits are expected to correct over time, and banks continue to create deposits through credit expansion.
Doubts Revealed
RBI -: RBI stands for Reserve Bank of India. It is the central bank of India, which means it controls the money supply and interest rates in the country.
Loan-to-deposit ratios (LDR) -: Loan-to-deposit ratio (LDR) is a measure used by banks to compare the amount of loans given out to the amount of deposits they have. A lower LDR means banks are lending less money compared to the deposits they have.
Money creation -: Money creation is the process by which the central bank (RBI) adds more money into the economy. This can be done by printing new money or by other financial methods.
Bank profits -: Bank profits are the earnings that banks make from their various activities, like giving loans and charging interest. Higher profits mean banks are making more money.
FY23-24 -: FY23-24 stands for the financial year 2023-2024. A financial year is a one-year period that companies and governments use for accounting and financial reporting.
Cyclical -: Cyclical means something that happens in cycles or repeats over time. In this context, it means the current situation with banks lending less is expected to change and go back to normal eventually.
