Macronomics: Falling Bank Credit Growth, A Rising Money Multiplier

There are interesting goings-on in the non-equity world. Just as stock markets seem to hit new highs every day, banking data shows a troublesome set of outliers.

Money Supply Growth Reverses Trend

Money Supply Growth is slowing, all of a sudden. M3 - which is the money supply aggregate that measures the sum of all deposits in banks - has started to reverse its recently found upward growing path.

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If you see this in conjunction with M0 (Reserve money) you’ll see how money supply growth has changed in character:

We know that in September 2013 RBI went on the offensive and invited fixed deposits from NRIs in dollars, with a promise to return the money in dollars. Banks were offered swaps (called the FCNR swap) where they would only have to pay the RBI 3.5% a year, so they could offer NRI’s 5.5% interest rates and get the money for a rupee yield of about 9%, which was similar to what they were offering for rupee deposits. RBI took the dollars and printed rupees to give the banks.

The concept introduced new rupees into the system - more than 200,000 cr. (2 trillion) rupees was added into M0 (as reserve money). This saw M3 also jump as banks suddenly had new cash to lend. M3 is, put simply, the sum of all deposits available plus bank capital.

You will notice that growth in M0 (the red line) was starting to move up even before that, in early 2013. However, the massive bump upwards was in September 2013.

The impact of that has mellowed, it seems, with M3 Growth at the lowest since October 2013. This is strange, even as equity markets seem to be rejoicing just about any piece of news.

The Concept

Most times we get confused about the concept of reserves. That banks must first get deposits in order to lend. That is no longer true. Banks lend first, and then find reserves that they must place with RBI (4% CRR, 23% SLR). If they can’t borrow it in the inter-bank market, they will borrow it from RBI.

If banks are not constrained by reserve ratios (CRR, SLR) then what are they constrained with? The answer is capital - all bank lending is measured by its capital (that is, equity capital plus retained profits) as a percentage of “risk weighted” assets. RBI prescribes risk weights for different asset classes, such as 75% for home loans less than 25 lakh, or 125% for loans above 75 lakh.

Banks need to have a reasonable Capital Adequacy Ratio (CAR), with the comfort factor being 12%. Many banks, including the behemoth SBI, had fallen to nearly 6%. (Capital is lost when there are defaults which further hits the CAR)

In recent times, RBI has tried to restrict the amount that banks can borrow from it, by restricting access to the repo window (only 0.25% of all deposits now). There is term repo and RBI kept adding to it, but even that has come down to only Rs. 60,000 cr. now.

Credit Growth Slowing Too, Lowest Since July 2013

Money supply growth is coming down because of the contraction in bank lending.

Banks aren’t lending quite as much, and it is a combination of high rates and a drop in capital adequacy that has hurt them.

And because they’ve slowed down lending, they’ve needed to cut down their investments in government securities (investments) as well.

The Investment to Deposit Ratio is the lowest since October 2008, and that was a crisis time. This is supposedly a normal time though part of this dip can be explained by lower SLR requirements (23% versus 25% then).

Higher Money Multiplier, Lower “Currency”

So are we finally getting rid of black money? It seems growth in currency (notes in circulation) is at the lowest as a ratio to bank deposits:

(In fact the current number at is the lowest ratio since 1952 and has been constantly reducing)

When people demand lower currency notes, money stays in the banking system. So money a bank lends out stays with a bank, which can then lend it out. In effect, more money is created. This is reflected in the “money multiplier” - that is, the ratio of M3 to M0.

This does not entirely reflect the reduction of black money but perhaps the greater confidence in Indian banks over the years. When people are confident of banks they will keep more money in banks.

But when you combine it with slowing credit growth, this means that lower credit is available to those people who generally might convert it to currency (lower income and rural segments of society). Meaning, relatively speaking, banks are lending more to corporate and industry rather than to such borrowers. Why would they do that, especially when corporate loans are so stressed right now? This might be evergreening, when you lend more so that the customer can pay back interest, and you don’t have to classify them as a default, which would further impair capital.

In comparison, here’s the US Money Multiplier, which is at abysmal lows largely because banks are depositing most of the money they has as excess reserves with the fed.

Impacts

While this is an outlier in macroeconomic data, what use is it to the investor?

Decreasing credit growth and M3 growth is good for controlling inflation which is largely a function of money supply. Banking profit growth will reduce though, as banks will not earn quite as much as they used to.

However, the increase in the money multiplier at the same time indicates potential evergreening of loans.

Evergreening has long term issues in banking. It just pushes the problem to later, and makes it a bigger problem.

Clearly this is not a signal of a very strong economy, although equity markets think all our problems are behind us. In addition, stealthily, the Dollar has climbed from below Rs.60 to Rs. 60.80 yesterday, which is another macro-indicator that something might be amiss.

Macroeconomic data is very slow and trend reversals are seen over months rather than days. So while the warning bells are visible, the impact will take six months to a year. We encourage a better understanding of the macro data, but please don’t use it for shorter term trading decisions.

Disclaimer

Nothing in this newsletter is financial advice and should not be construed as such. Please do not take trading decision

s based solely on the matter above; if you do, it is entirely at your own risk without any liability to Capital Mind. This is educational or informational matter only, and is provided as an opinion.

Disclosure: The authors at Capital Mind have positions in the market and some of them may support or contradict the material given above, or may involve a direction derived from independent analysis.

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