Issues related to Economic growth

Is RBI raising systemic risks by pushing retail credit?


From UPSC perspective, the following things are important :

Prelims level: Not much.

Mains level: Paper 3-Is RBI raising systemic risks by pushing retail credit?


Credit driven growth may not lead to sustainable growth.

Credit driven economic boom

  • RBI and govt. acting in line: Both the government and Reserve Bank of India (RBI) have acted in line with their stated commitment towards the defined fiscal and monetary stability framework.
    • Given the pressures of a dwindling growth rate and limited fiscal and monetary elbow room, this is commendable.
  • Growth without increasing systemic risk: It is critical that the decisions taken to revive growth have a high likelihood of success without increasing systemic risk in the medium to long run.
    • Recent push may add to systemic risk: In this context, it may be argued that RBI’s recent push for retail credit growth would add to systemic risk, while the benefits for India’s gross domestic product growth (GDP) may be limited.
    • Credit-driven economic booms always end in economic misery.
  • Credit is a necessary evil: To pump-prime an economy, very few tools exist other than credit.
    • Thus there is all the more reason to handle it with care. In current economic growth frameworks, economic growth requires
    • Quite often, credit creation is the ultimate source of capital.
    • If the government spends by increasing its fiscal deficit, government debt increases. If the private sector borrows to invest and kick-start growth, its leverage increases.
    • What could be the best source of credit? The best use of credit is when it is used to finance real assets in the economy.
    • Creation of financial asset: When credit does not create real assets, it inevitably creates financial assets such as bonds held by investors, loans held by banks, or accounts receivables held by firms.
    • The precursor to a crisis: An overabundance of financial assets created by credit is a precursor to a crisis.

How types of loans matters for growth and risk of the system

  • How money is used matters for reviving sustainable growth: Taking a consumer loan to splurge on a vacation or celebratory dinner does very little to support long-term growth. It creates economic activity only in the immediate period.
    • Which sector should be pushed to ramp up credit and how that money is used become important if reviving sustainable growth is the objective.
  • In a paper titled Who Gets The Credit And Does It Matter, Thorsten Beck et al studied the growth dynamics of 45 countries for the period from 1994 to 2005.
    • Only loans to firms contribute to growth: The paper concluded that only loans to firms are linked to GDP growth, the argument being that firms use credit to increase their capital stock, and thus, real assets.
    • Loans to households do not add substantially to growth: Loans to households, while having desirable social outcomes in terms of boosting consumption and allowing households to tide over short-term cash flow mismatches, do not add to sustainable GDP growth.
    • It is debatable whether consumer loans need a push at all.
  • Retail and household debt growth
    • Retail loan growth, while currently below its 2016 peak of 20%, has been managing to grow at around 15%.
    • Household debt: In December 2019, RBI cautioned lenders on household debt levels and the associated risk on retail loans.
    • Relation with banking crisis: Higher growth in household debt is associated with higher chances of a banking crisis (Household Debt And Monetary Stability, IMF, 2017).
  • Consumer loans not always add to capital stocks: Another kind of consumer loan, the home loan, need not always add to incremental capital stock. Given how slowly the supply of homes responds to demand in the short term, excess credit supply is known to add to the risk.
    • Of course, consumer loans such as education loans, which upgrade human resources, are a notable exception.
    • In fact, mortgage booms have played key roles in most credit blow-ups.
  • Surprising steps by the RBI
    • Risk weight of consumer loans lowered: Surprisingly, RBI reduced the risk weight for consumer loans other than credit card debt from 125% to 100% in September 2019.
    • Waiver to CRR requirement: Recently, RBI decided to waive lenders’ cash reserve requirement against new exposure to home, auto and Micro, Small and Medium Enterprises (MSME) loans.
  • Futile attempts to revive commercial lending:
    • Home loan growth was hovering around 15% for the last two years.
    • Commercial credit growth falling: Growth of commercial credit (loans to industry and services as per RBI), which last exhibited 20%-plus growth in June 2012, has been falling.
    • Since 2016, its annual growth averaged around 6%, with a strong downward trend observed since March 2019.
    • Efforts to revive commercial lending have not borne fruit.
    • Misplaced belief needs to be relooked: This misplaced belief—“if not commercial, let retail loans revive the economy”—needs to be re-looked.
    • The simplistic understanding that any credit uptick can revive the economy needs to change.
  • What retails at best can achieve? India’s retail credit push, if successful, may at best check the downward trend in GDP growth.
    • The argument that it will revive growth is based on optimism.
    • The assumption here being that consumption will drive the current capacity utilization of 69% to somewhere above 85%, which will trigger capital expenditure.
    • This assumes that the consumer loan boom, already a decade old, will continue for another 3-4 years.
  • Chances of household balance sheet weakening: In an environment of low job growth, it is difficult to see how household leverage will not increase.
    • If capacity utilization does not pick up sufficiently to revive growth, then along with banking and corporate balance sheets, household balance sheets will also be weakened.
    • Over the next 3-5 years, the downside of RBI’s retail push appears at least as significant as the upside.


  • Polity stability needed: The government and RBI must make more determined efforts to revive corporate activity. Policy stability and confidence in the business environment may push commercial credit better than mere interest rate cuts.
  • Need to increase government spending: Among the options available, using good old government spending to stimulate infrastructure spending, and eventually, the economy, appears to be a wiser option.


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