Going by recent statements by various officials, they seem to endorse the view that were RBI’s recent measures to tighten liquidity remain in place for a few months, banks may have no option but to increase lending rates to protect their margins. While it’s difficult to tell what the central bank has in mind, and when it will reverse the measures, there is little doubt the shortage of liquidity could push up the cost of borrowings for a few banks, especially those that are more dependent on the wholesale market; the overnight call money rate has averaged 9.5% over the past week while one-year CD rates have moved up by about 100 basis points to 10%.
But for all the alarm raised by banks—SBI chairman Pratip Chaudhuri has said a repo hike would have been preferable to the liquidity squeeze—it is not clear all banks will be squeezed for liquidity, except for those with a relatively low CASA. For one, banks are collectively holding more gilts than they are required to; a couple of the bigger banks are sitting on 2-3 percentage points more than the mandated 23% of deposits. For another, the increase in non-food credit has stayed under 15% year-on-year, for the last eight fortnights. While it’s true that deposits are growing at barely 14% year-on-year, that’s coming off a higher base. Should the demand for money pick up, as we approach busy season—unlikely, given the current trends in manufacturing—and should the central bank persist with the tight money policy, it’s possible banks might fall short of liquidity. And, given the competition in the marketplace, it would be difficult for them to increase loan rates significantly. But, given that banks haven’t really responded to the RBI’s signals when it effected rate cuts a few months back—most of them opted to cut rates for specific products instead of a base rate cut which would have lowered borrowing costs across customers—they should refrain from increasing rates even if means a contraction in their net interest margins. As their owner, the government needs to persuade banks to leave loan rates unchanged, if only for their own good—smaller borrowers are already in big trouble, a rate hike will only add to restructured loans and non-performing assets. The RBI Governor has said on several occasions that banks need to sacrifice margins, pointing out that banks in India enjoy better margins than their counterparts in