Banking sector still requires wider reform

Recent policy tweaks from the RBI should help at the margins to boost bank lending, which has been moribund over the past few years. Most obviously, the 25bp rate cut this month means that the repo rate has now fallen by 150bp since January 2015. In addition, given that interbank rates have been dropping recently, regulatory changes such as the switch to the use of the marginal cost of funding to calculate lending rates should boost credit. But these changes are only likely to have a small impact on the ailing banking sector, which remains burdened by a build-up of bad debt. As we have argued previously, large-scale capital injections, increased private participation and a new bankruptcy code are all required to get banks lending again. The onus here lies with the government. Until progress is made, the banking sector looks set to remain a constraint on India’s growth prospects over the medium term.