Public sector banks in India are cutting interest rates on lending. This, despite RBI having kept its own policy rates unchanged, worried as it is about inflation and real estate prices. The central bank does not want to let control slip over growth in bank credit. Yet, it is clear that there is enough liquidity in the system, and that commercial banks have enough space to lower their lending rates?which will encourage credit growth?without profits taking a hit. This apparent disconnect is not new. In 2007 as well, there were phases in which RBI continued to signal high interest rates by raising its own benchmark rates and hiking the cash reserve ratio (CRR), while actual market conditions led to a reduction in regular bank lending rates. This complicates analysis of the Indian banking scenario, but to the extent that easier credit is good for commercial activity and consumer confidence, the outcome is welcome.
Now that public sector banks have cut rates, when will private sector banks follow suit? Will they wait for clarity on where monetary policy is headed? Perhaps. Indeed, several private banks have indicated that they will wait for the next policy announcement in April before taking a decision. The wait won?t be comfortable. Given the interest-sensitivity of borrowers and the choices available to them, if private banks do not also cut rates, they will start losing business. Even if they do not cut deposit rates, as all banks would like to, the loss in volumes will put pressure on their profits if public sector banks continue to cut rates. It is not in the interest of private banks to lose marketshare, especially given how hard-fought their gains have been in the face of public sector dominance. RBI, therefore, would be well advised to put these banks out of their misery by offering a clear direction for policy. Sure, complications have arisen from large inflows of capital, owing to the huge interest differential we now have with the world, and RBI?s policy of preventing rupee appreciation which has resulted in spurts of liquidity that the government is finding too costly to sterilise. But RBI can still cut interest rates and reduce the CRR so that both bank lending and upward pressure on the rupee are eased.