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The presence of higher capital buffers at banks lowers their cost of liabilities and gives a push to credit growth, according to a working paper published by the Reserve Bank of India (RBI) on 11 June.
“It is argued that higher CRAR (capital to risk-weighted assets ratio), by improving the financial health of banks, reduces their cost of borrowing, which in turn helps them to supply more loans at a cheaper price,” Ranajoy Guha Neogi and Harendra Behera wrote in the paper.
Similarly, the lending rate of banks was also found to be lower for banks with higher capital ratios. An increase in the capital position of banks helps them to not only access funds at cheaper costs but also increase credit as they reduce their lending rate, the paper said.
At the aggregate level in India, non-food bank credit growth has decelerated, despite the increase in capital ratio. The researchers said that the elevated level of gross non-performing assets (GNPA) has impacted the credit growth of banks negatively while high CRAR has contributed positively.
The recent fall in the growth of bank credit to industry in India could be a result of increased stressed assets in that sector and consequent apprehension of higher default. It could also be due to higher risk weight on loans to industry, which under increased regulatory capital requirement incentivises banks to cut down on risky assets with higher weights, the paper said.
As banks readjust their portfolios by reducing the riskier assets due to higher capital requirements and increasing mortgage backed securities like housing loans, the overall credit may increase. Thus, banks reduce higher risk weighted assets due to regulatory checks on leverage through CRAR.
“The growth rate of credit to industry falls over three quarters while growth of credit to housing sector increases over four quarters. The role of CRAR as a macro-prudential tool for financial stability thus holds true,” Guha Neogi and Behera said in the paper.