Banks Credit and Investment Dynamics assessing portfolio rebalancing vs crowding-out

Summarizing the paper (click here) titled “Banks’ Credit and Investment Dynamics: Assessing Portfolio Rebalancing and Crowding-out” under the Reserve Bank of India Working Paper Series.* The Paper is authored by Sanjay Singh, Garima Wahi and Muneesh Kapur. Click here to read my summary

The paper analyses the asset portfolio dynamics of Indian banks and the impact of their investment in G-secs on their profitability. The empirical analysis indicates that weak economic conditions and stressed asset quality encourage banks to increase their investments in government securities suggesting a portfolio rebalancing channel. Higher investment by banks in government securities in the face of higher government borrowings indicates the operation of a crowding-out channel. Its impact can be mitigated to an extent by the central bank’s market operations. The crowding-out is lower for banks with better asset quality and higher capital adequacy. An increase in the share of government securities in banks’ asset portfolios is found to have a favourable impact on the profitability of public sector banks, pointing towards a better risk-adjusted return from investment in G-secs relative to loans. Overall, policies aimed at strengthening the asset quality and capital position of the banks can lead to an enhanced flow of bank credit to the productive sectors.