Low loan demand slowing impact of policy on banks

Bank of India?s aim of effective transmission of policy steps is hitting a roadblock because of slow demand for bank credit and return of surplus liquidity in the system, bankers said.

The central bank?s constant reminders to improve transmission suggest that the objective has not been realised.

?Transmission of monetary policy is something that we worry about all the time,? RBI governor D Subbarao had said on July 27 in his first quarterly review of the 2010-11 policy.

The challenge of improving monetary policy transmission is certain to be on RBI?s agenda on September 16, the day it will unveil its first ever mid-quarter policy review.

Bank?s response

Starting March, RBI has raised its overnight repo (lending) rate by 100 basis points and reverse repo (borrowing) rate by 125 bps in four steps to tame rising inflation.

The response from banks to these has been delayed and muted — the country?s biggest lender State Bank of India hiked its benchmark prime lending rate only once, by 50 bps in August.

Most other banks have also deferred action to August, or after the fourth round of hikes in late July.

Bank officials claim increase in loan and deposit rates mirrored RBI action.

?Transmission has happened over a period of time and it will continue to happen. But there is always a time lag, it does not happen immediately,? said DL Rawal, chairman and managing director, Dena Bank.

And now, with liquidity improving and demand for loans still weak, banks may not respond in a hurry to RBI?s hikes in the near term, such as is forecast is likely on September 16.

?If there is ample liquidity and low (credit) demand, banks cannot hike rates,? Rawal said.

In an ongoing poll, economists said RBI would raise the reverse and repo rates by 25 bps each on September 16.

Low demand, high liquidity

The hesitation to ramp up lending rate further arises from worries higher interest cost may hurt the fragile credit demand.

The first quarter of 2010-11 ?was not good for us in terms of credit growth?, noted Anil Girotram, executive director, Andhra Bank.

?Demand is improving, but it is still below our expectations,? he said.

Over April-May, the first two months of 2010-11, credit demand was evidently sluggish: as of May 21, it was down 0.5% compared with the start of the year.

Late May, demand suddenly surged as telecom companies borrowed funds to finance their third-generation spectrum and broadband wireless licence fees.

As a result, credit by end June had expanded nearly 5% from April 1. And this trend continued until early July.

Then it was back to square one: in the fortnight ended July 16, credit contracted 1.1%. Since then, loan growth has remained muted (see table below).

New data confirms that the sharp growth seen in June didn?t sustain, and the current annualised credit growth of 20% (in line with RBI?s desires) reflects the one-time big bank credit demand from telecom companies in late May-early June.

Given the low credit demand and recent improvement in liquidity, bankers rule out another hike in deposit or lending rates in the medium term, even if RBI ups key rates on September 16.

NS Srinath, executive director, Bank of Baroda, expected banks? rates to ?remain stable for some time? as ?there is no problem with liquidity. It is ample for us?.

Recent improvement in liquidity is another factor that is making banks reject proposals to raise loan rates even as economists forecast another round of hikes by RBI.

Last week, the first in 13, banks? cash deposit with the central bank exceeded borrowing in the ?liquidity adjustment facility? or LAF.

The LAF transactions are a ready gauge of banks? liquidity. This development was probably set off by government spending, economists said, noting that on August 21, the government paid Rs 140 billion subsidy to public sector oil retailers to bridge the cost-sale price gap.

Base rate

The new statutory minimum loan rate for banks, the so-called ?base rate?, has also not reacted to RBI?s policy moves.

The system, introduced on July 1, was expected to respond better than the old benchmark prime lending rate.

Banks have kept base rate unchanged even though the central bank had raised repo and reverse repo rates twice since the system was introduced, and the prime lending rate was hiked.

However, bankers say the new system has not failed. It is more about its newness and the structure of outstanding loans.

?Base rate was just implemented in July, and today in the banking system less than 20% of accounts are linked to base rate,? OP Bhatt, chairman, State Bank of India said recently.

With 80% of the loans linked to the old prime lending rate structure, it made sense to raise the prime lending rate, he said.