State Bank of India (SBI) has walked the talk. Following the cut in the cash reserve ratio (CRR), the country’s largest lender has dropped its base rate. Does this signify that the peak of the interest rate cycle is behind us and other banks will follow suit?
Recent economic data and the dovish tone of the central bank in its latest monetary policy assessment certainly indicate rates are unlikely to go higher, but for most other banks, it is a difficult decision to make.
The cut in CRR, or the portion of deposits banks have to keep with the Reserve Bank of India (RBI), will release Rs.17,000 crore into the system, but for most banks it doesn’t necessarily mean the cost of funds will come down a lot. At the same time, credit growth is not all that hot. Indeed, non-food credit growth this fiscal is the lowest in four years.
So, in a scenario where there seems to be enough liquidity, but not enough borrowers, the question for banks basically boils down to this: Whether they are willing to sacrifice margins and expand credit?
The answer is not so simple. Firstly, can credit growth be fuelled by reducing interest rates? In the midst of an economic slowdown, capital goods makers and builders are unlikely to kick-start investment just because lending rates are down 25 basis points; RBI itself has said as much earlier. A basis point is one-hundredth of a percentage point.
In all likelihood, a drop in lending rates would see an increase in retail loans such as those that finance house or vehicle purchases. But even that isn’t assured as consumers have cut discretionary expenditure, as slowing sales of cars and homes show.
Secondly, will the increase in the loan book compensate for shrinking net interest margins? Remember that competition is high and just cutting interest rates may not always spark credit growth. Maintaining a certain level of net interest margin is important because the spectre of non-performing loans is still around to haunt bank balance sheets. It means banks will have to set aside more money against these bad loans; in such a scenario, they would like to maintain a certain level of profitability.
The festival season, which has just started, should provide some clues. But one shouldn’t be surprised if all banks don’t follow SBI’s lead and stick to their current rates before waiting for clearer signals that the economy has bottomed out and the central bank will turn towards boosting growth.