Gives banks access to funds at a lower rate, but banks may not find it easy to lend as credit-worthy borrowers limited
Full marks to Shaktikanta Das for trying. While lower interest rates alone cannot create demand for credit and the lower cost of funds for banks cannot push them to lend, there is absolutely no doubt the Reserve Bank of India’s efforts to lower interest rates through a set of measures can make a difference, if only at the margin. Indeed, efforts to use money-market instruments to try and bring down interest rates, at a time when it is unable to trim the repo because retail inflation is ruling at a multi-year high of 7.4%, is to be applauded.
To be sure, banks may still be reluctant to lend since there is a genuine shortage of credit-worthy borrowers, and many banks are still grappling with loan losses. But, giving them a six-month CRR-break for incremental home, auto, and MSME loans is a great idea; there is no blanket benefit from a CRR cut but, at the same time, it is incentive to lend. So is the move to ask lenders to peg interest rates on MSME loans to an external benchmark. It may not work, but there is no harm in trying.
The big move, of course, is RBI providing banks with durable liquidity—one-year, and three-year money—at the repo rate of 5.15%, much like a long-term refinancing operation (LTRO). Again, this is being done for a limited quantity of Rs 1 lakh crore, but is a good experiment and should result in yields softening across the yield curve. Yields at the shorter end slipped by about 15 basis points on Thursday as banks stocked up. Yields on short-term corporate bonds, too, are expected to dip.
There are those who believe deposit rates, too, could come down, though that seems highly unlikely since deposit rates depend on a lender’s asset-liability mix. Also, interest rates on small-savings schemes are still high, and banks would be wary of losing deposits. Three-year money today costs close to 6%—so, that leaves banks an arbitrage of 85 basis points. Even if banks don’t want to pass on the entire gain to borrowers, there is enough room to lower rates.
Indeed, Das is batting for growth, which has collapsed—nominal inflation hit a 42-year low of 7.5% year-on-year (y-o-y) in Q2FY20 while real GDP rose at a six quarter low of 4.5% y-o-y. He is trying to stimulate demand at a time when capacity utilisation is as low as 69.1%. Loan growth over the past four or five months has averaged 8-9% y-o-y, having hit a two-year low of 7% y-o-y in some fortnights. This is because banks are apprehensive of lending to companies; in Q3FY20, the corporate portfolios of some banks contracted. With deposits growing at a faster pace than loans, there is abundant liquidity in the system—banks have parked a surplus of some `3 lakh crore with RBI’s reverse repo window. The timing for the overhaul of the the liquidity management framework, therefore, couldn’t have been better. Even as it has withdrawn the daily fixed rate repo, and the four 14-day repos every fortnight, the central bank has reassured the money markets that it would use the various instruments—overnight or longer-term repos, and reverse repos—to support liquidity in the event that there is a shortage. The central bank’s instrument to manage liquidity requirements would be a 14-day term repo or reverse repo operation at a variable rate and synchronous with the CRR cycle. If banks are not comfortable with giving up all their surplus to the RBi, they would need to park this in the inter-bank market.
What is worrying is the forbearance that the central bank has given banks for loans to the MSME sector. In January 2019,the central bank had given them one year before they downgraded loans on which there were defaults.That window has now been extended till December 2020. Banks may be overjoyed their loan books will look cleaner for some time, but such flexibility disturbs discipline. The fact is, banks are just coming out of a prolonged non-performing assets (NPA) cycle—the result of both reckless lending, and disruptions in the business cycles. Had banks red-flagged the troubled loans early in the day and provisioned adequately, rather than evergreening them, their balance sheets would not have been damaged to the extent they were. The central government has injected some `3 lakh crore of capital into state-owned lenders in the past few years.
Again, easing the asset classification norms for loans to the commercial real estate sector, by allowing a one-year extension on the date of commencement of commercial operations, is not a good idea. The reasons for the delay may be beyond the promoter’s control, but banks must recognise stress immediately, even if it means they will be left with less growth capital. However, this is better than reducing the risk weights on such loans. This paper has always argued that policy rate cuts don’t help transmission—that depends almost entirely on deposit rates. But, Das’s strategy could push banks to drop rates, even if it is for a short time.