Last week, I asked the chairman of a large public sector bank whether he would cut the loan rate after finance minister Pranab Mukherjee meets the heads of India’s public sector banks on 10 June. Indeed, his bank would cut its prime lending rate, or PLR, this month, but the decision to cut the rate has nothing to do with the meeting with the finance minister.
PLR is the rate at which banks are expected to give loans to their most creditworthy borrowers.
“There is no pressure on us (from the ministry) to cut loan rates. The market drives the rates. You are aware that we have already cut our deposit rates and it’s only logical that loan rates should be cut,” this banker told me over the phone. If it’s so simple, I wondered, why do bankers need to wait for the meeting with the finance minister to cut loan rates? Why can’t they cut rates right now?
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Delhi-based Punjab National Bank has the lowest PLR of 11%. State Bank of India, the country’s largest lender, has a PLR of 12.25%, and most of the other public sector banks’ PLRs range between 12% and 12.5%. For private banks such as ICICI Bank Ltd, HDFC Bank Ltd, Axis Bank Ltd and others, PLR ranges between 13% and 16%. Why has there been such a difference in PLR between public sector and private banks even though they operate in the same market?
Such anomalies aren’t seen in other pockets of the financial sector. For instance, the premium for insurance policies at the state-run Life Insurance Corp. of India are on a par with that of private sector insurance companies such as ICICI Prudential Life Insurance Co. Ltd and HDFC Standard Life Insurance Co. Similarly, in the asset management business, mutual funds run by public sector banks do not offer any special rebates on their unit prices to their customers. Even in telecom, state-run companies compete with private firms fiercely and there is no difference in tariffs.
This means India’s state-run banks do not operate in a free market even though the chairman quoted at the beginning of this column chooses to believe so. For them, the state is god and bankers do not question god’s wisdom.
Since October, the Reserve Bank of India, or RBI, has cut its policy rate from 9% to 3.25%, lower than its administered bank savings rate of 3.5%. There is plenty of liquidity in the financial system, with the banking industry on an average parking around Rs1.2 trillion with the regulator in June. The rates at the overnight call money market, from where banks borrow to tide over temporary asset-liability mismatches, are hovering between 3% and 3.25%, and government bond yields have also declined despite the Centre’s huge borrowing programme to bridge its rising fiscal deficit.
Still, banks are finding it difficult to bring down their loan rates. Why? There are many reasons. Indeed, they have pared their deposit rates, but the cost of money does not come down automatically following the cut in deposit rates since the new rates are paid only for fresh deposits and banks need to continue to pay the old high rates on existing deposits till they mature. Also, banks’ ability to cut deposit rates is restricted, as they fear losing money to small-savings schemes run by the government. Most of these schemes offer 8% returns; moreover, they offer tax benefits. Most of the banks are now offering less than 8% on their one-year deposits and interest earned on such deposits is taxable.
Finally, banks are reluctant to cut PLR because certain loans are benchmarked to their prime rate. If they lower it, their earnings on such loans will be pared drastically. For instance, loans to exporters are given at 2.5 percentage points lower than PLR. Also, all small-firm loans are priced cheaper than a bank’s PLR. Overall, such concessional loans account for about one-third of a bank’s loan portfolio and when banks lower their PLR, earnings on these loans will go down sharply, affecting their profits.
So, if the finance minister wants the state-run banks to cut their PLR, he should abolish the system of lending at rates below PLR. Instead of forcing banks to support exporters and farmers, the government can offer them direct subsidy. Now, banks do get 2 percentage points interest rate subsidy on farm loans, but that is not enough even to take care of their cost of funds and very high transaction charges for small loans. Once the government abolishes these concessional rates, it can ban banks from lending at below PLR to corporations too. Now, banks deliberately keep their PLR at a high level to avoid making losses on farm loans and export loans and, at the same time, offer loans at below PLR to their prime customers.
With the inflation rate remaining low, the government can also bring down the small savings rate and link such rates to yields on government bonds and treasury bills of comparable maturity as suggested by expert panels.
As a majority owner of public sector banks, the government should have a say on how these banks are run, but not at what rates they should lend. At the 10 June meeting, Pranab babu should not attempt to play god. Instead, he should focus on efficiency and scale. He can push for consolidation since the new government does not need the crutches of the Left parties that traditionally oppose mergers of banks for fear of job losses.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as a deputy managing editor of Mint. Please email comments to firstname.lastname@example.org