Cut in small savings’ rates critical for banks to get more deposits; without that, they can’t lower interest even if RBI cuts the repo
The sharp deceleration in growth over the past year, culminating in a jaw-dropping 5.8% year-on-year (y-o-y) in the March quarter, is enough evidence the economy is stalling. Although there is a clamour for a policy rate cut, high interest rates are not the main cause for poor growth though there is doubt that a smaller interest bill does make a big difference to small businesses. But while RBI may cut the repo by 25, or even 35, basis points today, the harder task will be to get banks to lower loan rates. There has been little transmission of the cuts in the repo rate into loan rates over the last several years for various reasons, including the asset quality pains of state-owned lenders and more recently, the moderating pace of growth in deposits. The central bank has tried to tweak the lending method—there was the base rate and now the MCLR—but banks are reluctant to lower rates for fear their margins will shrink. It also wanted to force them to peg loan rates to external benchmarks, but has desisted.
While banks have only themselves to blame for the sorry state of their balance sheets, they must be free to charge whatever rate they feel is needed to cover costs and earn a surplus; they must have the flexibility to decide how to play the competition and remain in business. It is a fact that, over the past year or so, deposits have been hard to come by, whereas the demand for loans has picked up. This has made it difficult for banks to lower the interest rate on deposits since they rightly fear the savings would flow elsewhere. After all, deposits account for the biggest chunk of borrowings for banks, and not borrowings in the wholesale market that are short-term in nature. One way to address the problem is to lower the interest rates on other savings schemes—EPF, PPF, post office schemes—so that the relative attractiveness of bank deposits returns. So far, the government hasn’t had the stomach to take on the unions, but if it wants banks to lower loan rates, it must start by bringing down rates on all competing savings products. Again, for loan rates to come down, expenses on overheads too must come down. Many of the the public sector banks have a larger share of the cheaper CASA deposits, but their workforces are large and their employee costs disproportionately high. However, they are nearly bankrupt and have been asked by the central bank to stay out of the loan market. These banks must use technology and digitisation and hire only the kind of talent needed to operate in this new environment.
Former RBI governor Raghuram Rajan had observed that one reason for the high premium or spread charged by lenders was because of the large number of defaults. Banks need to be far more vigilant, careful and honest while appraising borrowers than they have been in the past. A better credit culture would reduce the need for large spreads. To be sure, these changes will occur only over the longer term. In the near term, lower interest rates on small-savings schemes might make banks less apprehensive of trimming rates on deposits and embolden them to cut interest rates on loans by more than five or ten basis points at a time.