Mumbai: Inefficiencies in Indian banks have meant the large cuts in official rates have not been fully passed on to customers, hampering the effectiveness of monetary policy, the head of the central bank said on Wednesday.
Delayed financial sector reforms in India were necessary to open up long-term financing for infrastructure projects, rather than just relying on banks to deliver the funding, Reserve Bank of India governor Duvvuri Subbarao said.
“There is a degree of stickiness and non-transparency in bank lending rates,” Subbarao said at a business conference.
“The intermediation cost in India is still high, largely due to high operating cost. Although overall efficiency and productivity have improved, resources are not being utilised in the most efficient manner.”
Banks have cut their prime lending rates by around 200 to 250 basis points since October 2008, around half the 425 basis points of cuts the RBI made in the repo rate, its short-term lending rate, between October 2008 and April.
Further, most bank customers are not eligible for the prime lending rate and so pay higher rates for loans.
“The challenge for Indian banks, therefore, is to reduce costs and pass on the benefit to both depositors and lenders,” Subbarao said.
He said banks would need to augment their capital base and upgrade risk management systems, noting the Basel 2 framework for banks globally provided a standard to assess various risks and calibrate capital requirements.
“Buffering the capital base of banks is obviously a standard and much-needed response to risk management,” he said.
A meeting of Group of 20 finance ministers in September had agreed that banks should hold more and better quality capital.
Subbarao said financing India’s massive infrastructure needs would be a major challenge for Indian banks, and said stalled financial sector reforms could facilitate better availability of long-term financing.
“This huge and growing demand of infrastructure finance will have to be met even as banks wrestle with expanding their traditional banking services,” he said.
“While infrastructure typically requires long-term funding, the deposits of banks, their main source of funds, are relatively short-term.”
Meeting fund requirements for infrastructure would require pending reforms to be cleared, he said. The government has estimated a funding requirement of about $500 billion to fund roads, airports, power and ports in the five years to 2012.
“In advanced economies, the long-term finance space is filled by insurance companies and pension and provident funds. If some of the pending legislation gets through, in India too we can expect new sources of long-term financing to open up.”
Subbarao said repurchase agreements or repos in corporate bonds would start soon.
“Repos in corporate bonds are slated to start soon. We expect to issue final guidelines by end-November,” he said.
The Central bank expects to come with final guidelines on repos in corporate bonds by end-November, which is expected to boost liquidity in the corporate debt market.
The participant can pledge a corporate paper in exchange of funds for a certain period and at a rate determined by the market.
As of now, repo transactions are allowed only in central government securities, treasury bills and state development loans.
Moving ahead, Indian banks are set to increase their presence abroad, while foreign banks will have a larger presence in India, Subbarao said.
Commenting on the ongoing financial inclusion programmes, the governor said, the effort should be to give access to at least minimal financial services to the excluded rather than chasing a target.