Indian banks received a light rap on the knuckles from Y.V. Reddy last month. The Reserve Bank of India governor had asked, in the course of his monetary policy announcement on 29 January, why banks were not charging lower interest rates on their loans despite ample liquidity in the financial system.
Some banks have responded. Allahabad Bank, Corporation Bank and Canara Bank said on Tuesday that they would be cutting lending rates. Earlier, mortgage lender HDFC had also announced an interest-rate cut. Public sector bank chairmen are due to meet the finance minister on 12 February, where they are likely to be once again asked to bring down interest rates.
There is perhaps more to the recent rate cuts than moral suasion. Banks will have to try harder to maintain their recent growth rates—and a price cut is a normal strategic response to any slowdown in business.
The credit deceleration over the past two quarters has been far sharper than expected. Mortgage lending is now growing at 15% a year, which is very low when compared with the scorching growth rates of the past five years. (Most of the recent cuts are for housing and consumer loans, which are most responsive to interest rates.)
But cutting rates at this juncture comes with attendant risks. Deposit rates will have to be brought down in tandem with lending rates if banks are to maintain their net interest margins, a measure of their profitability. The back-room boys doing risk management at various banks will have to have a say in the matter.
And the business of cutting borrowing rates is not just about small deposits made at branch counters. Most banks have also gorged on high-cost deposits from companies and large investors last year. These deposits have increased their overall costs. Till they are lying in bank ledgers, lending rate cuts will shave precious basis points off bank profit margins. Bankers say that many of these high-cost deposits will mature in March.
Will banks stay away from expensive bulk deposits this year? That may be unlikely, given the incentives to window-dress balance sheets and impress investors with sheer size.
(Is there a case for lower lending rates right now? Write to us at firstname.lastname@example.org)