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The Reserve Bank of India (RBI) in its working paper titled ‘Banks’ Credit and Investment Dynamics: Assessing Portfolio Rebalancing and Crowding-out’ has showed that weak economic conditions and stressed asset quality encourage banks to increase their investments in government securities suggesting a portfolio rebalancing channel.

According to the released paper, higher investment by banks in government securities in the face of higher government borrowings indicates the operation of a crowding-out channel, and 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.

Reserve Bank of India also noted that an increase in share of government securities in banks’ asset portfolio is found to have a favourable impact on 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.