Reduction In Bank Rate Will Not Lead To Higher Credit Offtake, Say Experts

Mumbai, Aug 25: | Updated: Aug 26 2002, 05:30am hrs
There are very few takers for the pevailing wisdom that a Bank Rate cut would help economic revival. Even as the Reserve Bank of India (RBI) remains commited to a softer interest rates regime, experts feel that rates are already down and further reductions would not lead to higher credit delivery. However, the cost of a further reduction would be quite high and would increase banks vulnerability.

While RBI governor, Bimal Jalan, has denied any short-term plan for a Bank Rate cut, he has said that the stand on effecting a 50 basis point (bps) cut if necessary, still stands. However, money market players have already discounted the possibility of the near term rate cut.

Conevtional wisdom says that with the prevailing liquidity slash in the market, along with in-control inflation rates, the stage may now be perfect for a Bank Rate reduction.

But who is going to benefit from a Bank Rate cut Who will bear the cost, asks ABN Amro Banks chief economist, Ajit Ranade. I doubt whether a Bank Rate reduction could help bank credit offtake growth. Lending in housing sector has been good, that means banks are doing fine in retail lending but the moot question is whether a rate cut could lead higher credit deliveries to corporates, says a sceptical Dr Ranade.

Interest rates will not pose a hurdle for credit growth, he quipped, adding that the elasticity of credit in response to Bank Rate reductions is not very strong.

His views reflect last fiscals scenario, where the 100 basis points reduction in the Bank Rate seemingly had little impact on the economy. It may be also recalled that banks have slashed their deposits rates in recent times. However, they did not effect any revision in their prime lending rates.

And if higher credit offtake is the ultimate goal, then banks need to be comfortable with their lending. In the backdrop of bulgeoning non-performing assets, a conducive legal system is needed for better and smoother recovery. If legal provisions in the system backs banks lending, credit will automatically go up, irrespective of interest rates, feels DSP Merril Lynchs senior vice president (debt), Jayesh J Mehta. The Ordinance (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Ordinance 2002) would really benefit lending activties, seconds Dr Ranade.

Experts pointed out that the revival of economy is a real sector problem, not a monetary one. And the answer to this problem is not in reducing the Bank Rate, they feel. The more you discourage savings, the more you discourage investments, and that would have an adverse impact on the economy. One trend can easily be traced and that is people are now moving on to hold physical assets, rather that financial assets, and that could easily spell doom for the economy. Low interest rates regime should have been earned, no one can forget this, are some of strong words emanating from banking gurus.

Opines HDFC Banks treasurer, Sudhir M Joshi: Rates are already low. It is very unlike that the central bank will bring the rate further down in the near future. Reduction in the Bank Rate would have no impact on the credit offtake. If liquidity of around Rs 18,000 crore could not lead to any growth in credit delivery, then what will a Bank Rate cut do

However, some treasury heads have contrasting views. They pointed out to the prevailing anomalies in the interest rate front. If you see the overnight call money rates, which are market determined, the rates are hovering below the repos rate of 5.75 per cent. This clearly indicates the scope for rate reductions. Some bankers also point out the possibilities of arbitrage in the prevailing scenario. Borrowing banks can borrow funds from the call market and park it in the RBI repos-auction. And with the liquidity slosh in the inter-bank markets, call rates are expected to rule below the floor rate of 5.75 per cent.

Again, the one-year interest rate swap is now around 6.15 per cent, well below the Bank Rate. And money market players, thus, are of the view that the current Bank Rate is artificial. The remedy for them is a Bank Rate cut, which has remained unchange at 6.5 per cent for quite sometime now.

Economists, however, argue that the low yields on government securities are only due to the liquidity slosh. It is dangerous, the market rates could go below the cost of funds, they feel.

Says Dr Ranade: If there is any Bank Rate cut, the cost will be too high for banks, and that will increase their vulnerabilty. The beneficiary is only the Government, with reducing cost of borrowing programmes. This could only translate into economic growth, if and only if there are some industrial activities out of this funds.

Reductions in lending rates would also translate into greater stress for the banking system as banks interest income would be adversely effected. Economic theory suggests that a decline in interest rates is expected to boost investment demand, and in turn, give impetus to production growth. However, the need of the hour is to push overall demand, particularly consumer demand. For that, the economy needs a slew of concomitant policy measures, bankers and economists point out.