Public sector banks that account for about 70% of the Indian banking industry have recently slashed the rate of home loans to 9-9.50%. The maturity of such home loans normally varies between 15 and 20 years. Incidentally, these banks, along with their private sector peers, are offering around 10.5-11% interest rate on one-year deposits. This illustrates the mispricing of risk by Indian banks, being forced by the government, their majority owner.
The key reason for the unprecedented liquidity crunch the global financial system has been witnessing since mid-September after the collapse of the Wall Street investment bank Lehman Brothers Holdings Inc. is mispricing of risk.
The Indian government, in its enthusiasm to bolster slowing economic growth, is now goading the banks to commit the same sin. Once the crisis gets over, these banks might find themselves in bigger trouble. The availability of loans is more important than its price for all segments of borrowers and if the government continues to dictate at what price loans should be given and to which sectors, it may end up killing the banking industry.
Also Read Tamal Bandyopadhyay’s earlier columns
Corporations and individual consumers want money from banks. So do mutual funds and non-banking finance companies, or NBFCs. Real?estate firms and airlines too want cheap money from the banking system as they are finding it difficult to cope with the sudden slowdown in their sectors. The list will get longer as more and more sectors feel the heat of the downturn. Indeed, the banking system should lend a helping hand to tide over the crisis but they should have the freedom to price the loans. Instead of being blackmailed by the industrial lobbies, the government must use its discretion while accommodating their demands for money.
That’s because even in this hour of crisis, smart consumers can take the banking system for a ride. For instance, all agricultural loans up to Rs3 lakh are given at 7%. Since the end use of such small-ticket loans is not monitored well, the consumers can park the money in bank deposits and earn 10.5-11% interest. In other words, there is a window for risk-free 3.5-4% arbitrage opportunity for small farmers. Such windows can be closed if the banks bring down their deposit rates. Why aren’t they doing it?
Before we find an answer to this question, let’s take a look at the steps taken by the Indian central bank to ease the liquidity constraints and make credit available.
It has reduced its policy rate by 150 basis points in stages since 20 October to 7.5%. One basis point is one-hundredth of a percentage point. The cash reserve ratio or the portion of deposits that banks need to keep with the Reserve Bank of India (RBI) has been reduced more sharply—by 350 basis points to 5.5%—releasing about Rs1.4 trillion into the system. Besides, RBI has also cut the statutory liquidity ratio or the portion of bank deposits that needs to be invested in government bonds by 100 basis points to 24%. This has freed another Rs40,000 crore worth of deposits that can be used to lend to corporations and individuals.
There are other measures, too. For instance, banks can borrow up to Rs60,000 crore from RBI for three months to lend to mutual funds that are facing redemption pressure and liquidity-stressed NBFCs. This facility will continue till March. RBI has also raised the interest rate ceiling on non-resident Indian deposits substantially and corporations have been allowed to raise external commercial borrowings, or ECBs, up to $500 million (Rs2,500 crore) per financial year and for this, they do not need any special permission from the regulator. Both NBFCs as well as housing finance companies have been allowed to raise short-term ECBs.
Finally, RBI is also encouraging Indian firms to buy back their foreign currency convertible bonds or FCCBs that are currently trading at a steep discount. The buy-back of FCCBs can be financed by a company’s foreign currency resources or out of fresh ECBs.
Are these measures showing results? Yes. Can they take care of the credit needs of companies? No.
Banks have cash in their coffers. Until recently, they were heavily borrowing from RBI. Now, they are parking their excess liquidity with RBI daily. In the past one year till the first week of November, they have lent Rs5.72 trillion. The comparable figure for last year was Rs3.91 trillion. In percentage term, the loan growth has been 27.7% this year against 23.4% last year.
But the current pace of lending will not be enough to take care of the loan demand. This is because most of the other sources of funds have dried up. Going by the RBI data, in fiscal 2008, Indian corporations raised Rs2.40 trillion through equity issues, bonds and ECBs. Besides, private equity funds put in another Rs80,000 crore in Indian companies last year. So, about Rs3.2 trillion or roughly 50% of loans given by the banking system came from non-bank sources.
With non-bank sources drying, to catch up with the demand for money, bank credit needs to grow by at least 40%! This is absurd and no economy can sustain this. Besides, where is the money to lend? The growth in deposit has actually come down—both in absolute as well as percentage terms. The deposit growth in the past one year has been Rs6.03 trillion or 20.7% against Rs6.09 trillion or 26.4% in the previous year till November 2007. So, the deposit rates will continue to remain high and the perception about liquidity crisis will stay unless the other sources of money open up.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai bureau chief of Mint. Email comments to firstname.lastname@example.org