How Notebandi Brought Credit Growth to a Standstill

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However, according to an article in Livemint the opposite seems to be true. Demonetisation sucked out liquidity and slowed down the growth of bank credit.

Reserve Bank of India (RBI) data shows that bank credit slowed in the second half of 2016-17. As on 30 September 2016, the annual rate of growth of bank credit was 12.1%. That year-on-year growth rate decelerated sharply to 5.4% by 31 March 2017. It indicates the banking system is yet to recover from the after-effects of the note ban.

Interestingly, the rural regions of the country bore most of the brunt of the lending slowdown. RBI data shows that growth in rural loans between 30 September 2016 and 31 March 2017 was a mere 2.5%. The picture becomes clearer when you compare it with growth of 12.9% in the second half of 2015-16.

There is little doubt that the note ban hurt rural India and that, as at end-March, loan growth was far below its pre-demonetisation levels.

Most of the deterioration in rural lending was due to public sector banks.

PSBs dominate the banking industry in India with more than 60% of the total outstanding loans. They chose the easy life of issuing big-ticket loans to large corporations over the hard work of reaching out to many small retail subscribers. Extending credit to small and medium enterprises (SME) was also limited - to the extent of meeting priority sector lending targets set by regulators.

Moreover, large-scale bureaucracy and a lack of autonomy ensure the sub-optimal profitability and asset quality of state-run banks.

Many nationalized banks are in no position to lend, saddled as they are with bad loans. As on 30 September 2016, the stressed loans of state-run banks had surged to 15.8% of the outstanding loans. Even bank credit growth has fallen to multi-decades low.

In fact, nationalized banks saw their lending to rural India grow by a mere 0.5% in the second half of FY17, as compared to a growth of 13.3% in the second half of FY16.

Private sector banks haven't done much better. Even though rural credit in the second half of FY17 grew by a modest 14.6%, it was on a low base. And the slowdown is apparent when compared to the growth in the same period in FY16, which stood at 28.4%.

While the credit growth was already slowing down before demonetisation, the note ban brought it to a standstill.

However, as remonetisation gathers pace, bank lending and credit growth should pick up. The GST, and its implementation could prove to be a catalyst for credit growth going forward.

Does this mean bank's fortunes are set for a turnaround?

We don't think so. The non-performing assets (NPA) crisis facing the banking sector needs to be resolved to encourage any further lending, especially for public sector banks.

Return ratios of PSBs aren't likely to improve overnight on the back of the low-cost capital deluge or the steep rate cuts undertaken to boost credit offtake.

Instead of betting on the sector's turnaround, we've been advising subscribers to avoid losing money in PSU bank stocks. So, we turned cautious on the sector way back in 2014.

This was well before the market had caught a whiff of the NPA problem. We've recommended just two large PSU banks in StockSelect since then...and already successfully closed one of them.

We don't believe we can pick the safest stocks by speculating on sector trends. Rather, the time is ripe to buy safe stocks based on a hidden undercurrent.

For information on how to pick stocks that have the potential to deliver big returns, download our special report now!

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