Ghosts of Bad Lending

Context:  Growth of bank credit/ loans sometimes ends up with financial crises or recessions.

Why Credit Growth Hurts Economy

• The tendency of ever-greening of old loans: results in more capital getting stuck in inefficient firms while restricting credit to good firms/start-ups.

• Inefficient lending : results in rising NPA’s.

• Guarantee on MSME loans: addresses the problem of risk aversion on the banker’s part but leads to inefficient lending.

• The phenomenon of zombie lending: restricting lending to bad companies as well as good companies.

• Inefficient allocation of fiscal stimulus: Loans are given to inefficient State-controlled firms that can lead to a decrease in productivity/growth.

• Rising credit to firms having Low-Interest Coverage Ratio (ICR)(ability to repay interest on loans): while the fall of fresh credit going to High ICR firms hurts economic growth.

Way forward

• Use of Legible Database: to ascertain the amount of credit going into bad quality firms. 
• Plotting the fraction of total credit going into High ICR firms versus Low ICR firms.
• Efficient and well-directed fiscal stimuli.
• Transferring capital from least-productive to most-productive firms: can improve India’s labour productivity by 80%.