P Chidambaram argued many times that banks should absorb the rising costs of funds by squeezing their interest margins and, therefore, not always raise interest rates. He was criticised for trying to do bankers? job. In principle, finance ministers should not be telling bankers what to do. But in practice, it was really hard to fault the FM?s data. As reported by FE on Wednesday, many public sector banks have actually been able to absorb hikes in cash reserve ratio and repo rates by thinning down fat margins. This is not bad economics; indeed it is excellent economics. The thinning of margins forces banks to cut down flab and increase non-interest earnings like fees. Public sector banks do not get enough competition from the private sector and, therefore, many of the former have had the luxury of retaining big interest margins and bid cost structures. Most recent numbers show that the net interest margins of a dozen public sector banks are comfortably above the industry average. And, in a demonstration of just how badly banking needs competition, the bad habit of gorging on big margins is enjoyed by some of the older private sector banks as well. Interest margins in this sector exceed the national average in almost half the cases. The obvious exception is some of the new private sector banks. Some of them operate on much thinner margins. The record is mixed in the case of foreign banks. Margins vary widely among them primarily because of the sharp differences in foreign banks? individual share of low-cost funds procured overseas.
However, low level of competition is not the only reason that explains the large spread in interest earnings. Another major factor is the high costs of facilitating growth, especially in rural areas, and salary and staffing patterns that lack flexibility. These mean high costs that are virtually fixed. And bankers feel compelled in some ways to increase the spread. Cost reduction efforts can get a serious boost only if policy allows for synergies from faster consolidation of banks, relocating back office activities to low-cost locations and greater use of outsourcing. Some of these solutions, of course, are deemed by regulators as too radical to be implemented quickly.