The much ado about interest rate cuts by the RBI serves little purpose as banks are unwilling to lower their base rates
24-Jul-2015 •Vivek Kaul
I am writing this column in the last week of May. By the time you get around to reading it, the monetary policy meeting of the Reserve Bank of India (RBI) would have already happened on June 2, 2015.
The RBI, depending on how it feels, may or may not cut the repo rate. The repo rate is the rate at which the RBI lends to banks and acts as a sort of benchmark to the interest rates that banks pay on their deposits and in turn charge on their loans.
If the RBI does not cut the repo rate, you will soon see statements being made by senior officials of the Ministry of Finance (the finance minister, Arun Jaitley, and the chief economic adviser Arvind Subramanian) trying to tell the country that the RBI should have cut the repo rate.
Insinuations will also be made that the RBI not cutting repo rate is essentially the major reason holding economic growth back because consumers are not borrowing and spending, and businesses are not borrowing and investing.
Business lobbies led by the likes of CII and FICCI along with CREDAI (Confederation of Real Estate Developers Association of India) will come out with comments saying that a cut in repo rate would have really helped the companies they represent.
Even in the run up to the monetary policy, such pressure is already being applied. The Minister of State for Finance, Jayant Sinha, told a gathering of the CII on May 26: "We have achieved macroeconomic stability; inflation has come down. This now creates room for the Reserve Bank of India to cut rates. I am hopeful that on June 2, Raghuram Rajan will cut rates."
On May 22, Arun Jaitley had a similar opinion to offer. And so had Arvind Subramanian on May 27.
Nevertheless, if the RBI cuts the repo rate, the same set of people will hail its decision. But will that be enough and make any difference in the way things currently stand?
The RBI has cut the repo rate twice - by 50 basis points (one basis point is one hundredth of a percentage) - since the beginning of this year. But that hasn't led to banks cutting their base rates or the minimum interest rate a bank charges its customers on the loans that it gives out.
In fact, in late April, Jayant Sinha had pointed out that only 21 out of the 91 scheduled commercial banks in the country had cut their lending rates. This is despite the fact that the RBI had cut the repo rate twice - by 50 basis points. Further, this list included four public-sector banks, six private-sector banks and 11 foreign banks.
What this tells us clearly is that the government cannot even get the public- sector banks to cut interest rates. Given this, what is the point in going after the RBI time and again and asking it to cut interest rates.
The more important question here is why banks are not cutting interest rates. The answer perhaps lies in something that the previous RBI governor, D Subbarao, had once said: "There are several factors inhibiting the transmission process [of monetary policy] such as an asymmetric relationship between depositors and banks, administered interest rates on postal savings that are not adjusted in line with prevailing interest rate trends and rigidities in the financial markets."
The point that I am interested in here is the administered interest rates on postal savings. The interest rates on offer on postal savings deposits rarely move in line with market interest rates. Thus, they end up being typically higher than the interest rates on fixed deposits that banks have to offer. Products like the Public Provident Fund also are tax-free on maturity, making them even more attractive.
What this means is that banks cannot cut interest rates on their deposits beyond a point, without the risk of starting to lose money to postal deposits. In 2014-2015, the deposit growth of banks was at 11.42 per cent. This was a 51-year low. As The Financial Express reported: "The last time deposits grew at a pace below this was in 1962-63, when the increase was 6.5 per cent." While banks have cut deposit interest rates since January, with deposit growth at a 51-year low, it is difficult to expect them to cut interest rates beyond a point.
Also, in the case of public-sector banks, the bad loans are really starting to hurt big time. As RBI Deputy Governor SS Mundra pointed out in a recent speech: "The level of distress is not uniform across the bank groups and is more pronounced in respect of public sector banks...The stressed assets ratio [of public-sector banks] stood at 13.2 per cent, which is nearly 230 BPS [one basis point is one hundredth of a percentage] more than that for the system." The stressed assets ratio of public sector banks as on March 31, 2014, was at 11.7 per cent. The overall stressed assets ratio of banks was at 9.8 per cent.
The stressed asset ratio is the sum of gross non-performing assets (or bad loans) plus restructured loans divided by the total assets held by the Indian banking system. The borrower has either stopped repaying this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan by increasing the tenure of the loan or lowering the interest.
With bad loans piling up, if public- sector banks cut interest rates on their lending, it would mean lower profits from what they are currently making. And that explains why only four public sector banks had cut their base rates until April 2015, as Sinha mentioned.
To conclude, what all this clearly tells us is that the RBI cannot do much to get banks to start cutting their lending rates. The government can help by ensuring that the interest rates on offer on postal savings deposits move in line with overall interest rates. That would at least be a start.
Vivek Kaul is the author of Easy Money. He can be reached at [email protected]
This column appeared in the July 2015 Issue of Mutual Fund Insight.