Bank Recapitalisation and Credit Growth: The Indian Case

The continuing deterioration in asset quality of public sector banks in India since 2012 has had multidimensional ramifications. On the one hand, while significant loan loss provisions were required to be kept, eroding the profitability of these banks, on the other hand, it affected their risk-taking ability and resources available for on-lending to commercial sector. From a macroeconomic perspective thus, poor asset quality and lower economic growth reinforced each other into a vicious cycle. The government intermittently infused capital in the public-sector banks, but most of that was absorbed by the continuing deterioration in asset quality, delaying the revival in the credit growth cycle. This led to the question of how much capital infusion is necessary to kick-start the credit cycle. Using bank-wise data for the period 2008-18, the present study analyses this question in a dynamic panel framework. The findings of the study suggest that the relationship between bank capital and credit growth is non-linear. Any amount of recapitalisation in banks is may be helpful in accelerating credit growth. However, the study found the single threshold level 13.1 per cent of CRAR level would be optimal. Above this threshold level, incremental increase in bank capital has positive but declining marginal effects on lending.