As banks cautiously return to lending to contain bad debts, their preference for short-term, low-risk loans is stabilising the financial system but slowing credit to productive sectors needed for sustained economic growth.
Banks and financial institutions (BFIs) are lending again, but with extreme caution. In the first half of the year, lending to the private sector rose by 3.4 percent, or about Rs 187.66 billion, bringing total outstanding loans to Rs 5.695 trillion. By mid-January, lending had increased by 6.33 percent compared to the same period last year. Activity is picking up, but banks remain wary. They are largely prioritising short-term, low-risk loans as they continue to grapple with bad debts. Data from the central bank show a clear shift away from riskier lending. Loans to individuals and households now account for 37.3 percent of total credit, up from 35.8 percent last year. This suggests banks are trying to stabilise their balance sheets amid high non-performing loans. As a result, lending is increasingly concentrated in home loans and margin loans, while exposure to real estate and overdrafts has declined. Real estate loans have fallen by 5.4 percent and overdrafts by 3.3 percent. In contrast, personal home loans of up to Rs 20 million have grown by 7.8 percent, and margin loans have increased by 8.3 percent following the easing of limits. Consumer loans rose by 9.1 percent, construction lending by 7.2 percent, and transportation and public services by 6.2 percent. Manufacturing recorded modest growth of 4.4 percent, services lending remained largely unchanged, and agricultural credit declined by 1.1 percent.
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Despite these shifts, overall credit growth remains below the annual target of 12 percent. Banks’ caution is understandable. Home and share-backed loans are easier to recover if conditions deteriorate. They generate regular cash flows and pose fewer surprises. Past lending excesses left banks burdened with bad loans, making them reluctant to finance long-gestation projects with uncertain returns. Short-term lending allows banks to recycle funds more quickly, manage liquidity better, and remain compliant with regulatory requirements. A stable banking system underpins broader economic stability. Lower loan losses protect depositors’ savings and reduce the risk of a credit freeze. Home loans help sustain urban housing demand, while margin loans support stock market activity. In a slow recovery, safeguarding the financial system can be more important than rapid expansion.
However, excessive caution also has costs. Overly conservative lending can starve productive sectors of the credit needed to grow. Manufacturing, services and agriculture, in particular, require longer-term financing to expand capacity and create jobs. When banks pull back too far, economic growth suffers. Moreover, margin loans carry their own risks, as market downturns can quickly turn sound loans into problem assets. Heavy reliance on household lending may boost consumption, but it risks widening the gap between consumption and production. The path forward requires balance. Banks must strengthen credit assessment, not rely solely on collateral. Deeper sectoral knowledge, careful cash-flow analysis and closer project monitoring can redirect credit to productive uses without fuelling new risks. Policy tools such as credit guarantees, co-lending with development institutions and targeted refinancing can help share risk. Clearer regulations and faster dispute resolution would also support recovery. Playing it safe may shield banks in the short term, but sustained growth demands measured confidence. The goal is not to lend less, but to lend smarter.
