In the past, at every monetary policy meeting with bankers, the Reserve Bank of India (RBI) used to persuade them not to hike loan rates even when policy rates were raised. At the formal post-policy press conference, the RBI governor’s usual stance used to be “it’s up to bankers to take a call on their loan rates”, but the closed-door moral suasion has always been “don’t raise the loan rates as that will hurt growth”.
This time around, at the January quarterly review of monetary policy, RBI was seen persuading banks to raise loan rates while bankers were saying there’s no immediate plan to hike rates.
The best way to fight high inflation is to make money more expensive and dampen demand for it. Indian banking industry’s loan book has grown by 23.6% in the past one year against RBI’s year-end projection of 20%. So RBI wants banks to raise the cost of loans. They have done so in recent past but that’s not enough.
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RBI has raised its policy rate seven times in the past year, from 3.25% to 6.5%. During the same period, it has raised banks’ cash reserve ratio (CRR), or the portion of deposits that banks need to keep with RBI, by a quarter percentage point to 6% and cut the floor for banks’ bond holding limit from 25% to 24%.
With the average inflation rate for the fiscal at 9.4%, the policy rate continues to be negative, but RBI is not for an aggressive rate hike, as it fears that higher rates will hurt growth next year, particularly in the context of persistently high inflation and rising current account deficit.
At the same time, it wants banks to raise their loan rates. Indeed, when the yield on 10-year benchmark sovereign bond is hovering around 8.2%, a 20-year mortgage rate at 8.5-9% is too low, even if this rate is meant for the first two years and will go up in sync with the market rates later.
So what’s the best way to make banks raise their loan rates even when the policy rate is lower than the inflation rate? One possible way could be lowering the banks’ bond holding limit. Under banking norms, commercial banks are required to invest certain portion of deposits in government bonds, the so-called statutory liquidity ratio (SLR). Till recently, the floor for SLR was 25%. This means 25% of a bank’s deposits must be invested in bonds.
But banks traditionally invest more in government bonds as they offer reasonable returns with zero risk and, hence, there is no need to provide for bad assets. Typically, loans given to companies fetch higher returns but banks always run the risk of a loan going bad and set aside a portion of their profits to provide for such bad loans.
In December, the SLR floor was brought down to 24%. And, as a temporary measure, banks can even bring it down to 23% till April. This is to ensure they have enough excess bonds to borrow overnight money from RBI.
The banking regulator lends money to banks through its repo window, but banks need to offer government bonds as collateral to get such money. RBI can bring down the SLR floor to 23% on a permanent basis. This will allow banks to liquidate part of their bond portfolio and use the money to give loans to borrowers. But, more importantly, this will dampen banks’ appetite for bonds.
Once the demand for bonds is down, their prices will drop and yields rise. Prices and yields move in opposite directions. Rising yields of bonds will force banks to reprice their loan assets. Theoretically, if the benchmark 10-year bond yield touches 8.5%, banks will have no choice but to raise the rates for home and auto loans and all other loans given to corporations since sovereign bond yields, more than anything else, continue to be the benchmark for credit market rates in India.
This is, however, easier said than done as the Indian government needs to borrow money from the market to take care of its fiscal deficit, and banks are the major subscribers to government bonds.
Analysts expect the government to borrow at least Rs 3.6 trillion next fiscal, net of redemptions of bonds; and if banks refuse to buy such bonds because of low SLR requirement, RBI—the government’s merchant banker—will find it difficult to manage the borrowing programme.
Meanwhile, every Indian bank is wooing customers with all sorts to marketing gimmicks to mobilize deposits. In the fiscal year so far, banking industry’s deposit portfolio has gone up by 10.1%, or Rs 4.53 trillion, while the loan book got fatter by 14.6%, or Rs 4.75 trillion.
In the past one year, loan growth has been 23.6%, or Rs 7.1 trillion, while deposits grew by 16.4%, or Rs 6.98 trillion.
Banks have been using their capital to support the higher loan growth. But this cannot continue for long. So they are offering more on deposits and packaging them in different ways. For instance, banks are not selling one-and-a-half-year deposits. Instead they are looking for 500-day deposits. Similarly, three-month deposits are being packaged as 100-day deposits and three-year, 1,000-day deposits.
Many banks are offering 9.5% for 500-day deposits (you’ll get a quarter percentage point more interest rate if you’re 60 and above); but even then, banks’ deposit kitty is not swelling. This is because interest income is taxable.
In contrast, when one buys stocks and sells it a year later, one doesn’t need to pay any tax on the money made. If the market fall continues, people may look for safe haven and go to banks to park their money. Otherwise, banks have no choice but to rein in their loan growth.
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