Since January, the Reserve Bank of India (RBI) has cut its policy rate by half a percentage point to 7.5% in two stages, but most commercial banks have not passed on the benefit to their borrowers. With the financial year coming to a close tomorrow, I would like to believe that they will do so in the next few weeks, even if RBI decides to leave the rate unchanged in its annual policy for fiscal 2016 next week. The banks have not pared their loan rates as they don’t want to compromise on their interest income in the last quarter of the year and depress profits.
According to a recent Bloomberg report, only four of 47 lenders have lowered their base rate, or the minimum lending rate, after RBI cut its policy rate by 50 basis points (bps). One basis point is one-hundredth of a percentage point. I have been able to identify three of them—United Bank of India cut its base rate by 25 bps to 10% on 15 January; Union Bank of India by an identical margin to 10% on 27 January; and State Bank of Travancore by 10 bps to 10.15% on 16 March. The nation’s largest lender State Bank of India’s base rate has remained unchanged at 10% since November 2013.
Following the cut in policy rate, cost of money has come down in different segments of the market. For instance, the yield on 10-year government paper has dropped about 12 bps since the beginning of January; the drop in corporate bond yield is even sharper—about 28 bps. The overnight call money has also got cheaper by about 25 bps. However, these rates have no direct bearing on a bank’s loan rate; unless the banks pare their deposit rates, the loan rates cannot come down as the deposits are the primary source of money for giving loans. To be fair to banks, they don’t have too much of a flexibility to drop the deposit rates as competing savings instruments are offering higher rates. Besides, with a surge in the stock markets, people are also investing in mutual funds, which enjoy a tax advantage vis-à-vis the bank deposits.
Despite all these, the banks could have cut their deposit rates: Why do they need money when lending has been so tardy? In the past one year, till the first week of March, banks’ credit growth has been 10.2%, while deposit growth has been 11.6%, on a higher base. The Indian banking system’s loan book is now Rs.65.2 trillion against a Rs.85.5 trillion deposit portfolio. In fact, a few banks have actually pared their deposit rates and, yet, they are not willing to cut the loan rates simply because: while a cut in the loan rate affects a bank’s entire loan portfolio and its interest income goes down, a cut in deposit rates is applicable to only the new deposits while the stock continues to enjoy the old rates. This means, the cost of money does not come down overnight even after paring deposit rates.
The only way to bring down the cost of resources for banks is cutting the cash reserve ratio (CRR), or the portion of deposits that commercial banks need to keep with the central bank, on which they do not earn any interest. In a recent note, Soumya Kanti Ghosh, chief economic adviser of SBI, has pitched for a cut in CRR to enable banks to pare their loan rates. At the moment, banks’ CRR is pegged at 4%, and a 50 bps cut will release around Rs.43,000 crore into the system. Indeed, that will help the banks pare loan rates without hurting profitability, but since the system is not starved of liquidity, there is no pressing need for a CRR cut.
After the advance tax outflow in mid-March, the daily average liquidity deficit in the system in the fortnight ending 20 March has been a little over Rs.1 trillion. Around the same time, the government had surplus money of about Rs.1.6 trillion in its coffers. Since it is expected to spend the money by the fiscal year-end and early April, the liquidity deficit in the system will not stay. Besides, RBI has been continuously buying dollars from the market; for every dollar it buys, an equivalent amount of rupee flows into the system. In January alone, it bought a net of $12.13 billion from the foreign exchange markets—the highest such monthly purchase of the US currency since January 2008. Barring August, RBI has been a net buyer of dollar every month in the current fiscal, and its continuous dollar purchases have pushed up India’s forex reserves to $335.73 billion in mid-March.
While cutting the policy rate on 4 March, RBI governor Raghuram Rajan said that further monetary easing would need prerequisites, including “the pass-through of past rate cuts into lending rates”. The main reason behind banks’ unwillingness to cut their loan rates is the high non-performing assets, or NPAs, for which they need to set aside money. Besides, they also don’t want to lend for fear of rising NPAs. The gross NPAs of Indian banks had risen to 4.5% of the total advances in September from 4.1% in March, and the net NPAs had increased to 2.5% in the first six months of the fiscal year from 2.2%. Along with restructured assets, stressed loans of the banking system crossed 10% of total loans in September. In the December quarter, the situation worsened; according to India Ratings and Research Pvt. Ltd, the stressed assets could rise to 13% in the next 12 months. This will erode banks’ profitability and their ability to cut the lending rates further. Till the time the banks are able to get a handle on bad assets, they will resist lowering loan rates and won’t have the stomach to grow loan book.