Reserve Bank of India governor Sanjay Malhotra, in his job for less than a year, is breaking from the central bank's traditionally cautious approach and allowing banks more flexibility in lending, and corporates greater freedom to borrow.
Announced alongside a monetary policy review last week, the changes come after a decade of policies aimed at lowering risk in the financial sector after a bruising phase which saw bad loans rise to over a tenth of total assets. Stress in the banking sector peaked in 2018 and a clean-up since has brought down bad loans to a decade-low.
Malhotra's announcement, which made some of the changes effective straight away, suggests the central bank is convinced banks are ready to step up risk-taking.
He has junked rules that required banks to set aside more capital for lending to large corporations, permitted them to lend for acquisitions and increased the amount they can offer for IPO subscriptions, while also giving firms greater flexibility to borrow overseas.
"The recent regulatory changes are designed to enhance operational flexibility for banks and stimulate credit growth," said Sachin Sachdeva, financial sector head at rating agency ICRA.
Loan growth for Indian banks has been subdued over the past year, at under 10% so far this financial year. Loans to industry have grown an even slower 5% to 6% and the share of these loans in the banking portfolio has dropped over time.
The decision to allow Indian banks to lend for acquisitions, a segment so far dominated by foreign lenders and credit funds, came after lobbying by India's top lender State Bank of India (SBI).
"This has the potential to open the doors to an industry which market sources value at around $40 billion annually," said Madan Sabnavis, chief economist at Mumbai-based Bank of Baroda.
The market's response to RBI's moves has been significant, with the Nifty Private Bank index gaining 3.9% since the announcements were made on Wednesday, compared to a 1.9% gain in the benchmark Nifty 50.
Still, the relaxation on acquisition funding is "fraught with risks" of "asset-liability mismatches" for banks, said Vivek Iyer, partner and financial services risk leader, Grant Thornton Bharat.
"A prudent approach would be to specify certain long-term funding sources that would be matched for the purpose of acquisition funding," he said.
Banks are also being allowed to lend more against equity shares, a business previously seen as risky due to swings in the stock market. The amount individuals can borrow to subscribe to IPOs has been raised, at a time when that market is already seeing a frenzy of retail investments.
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