Finance minister P. Chidambaram did not persuade public sector bankers to offer cheap credit to borrowers at his meeting with these banks’ CEOs last week. This is a deviation from his past behaviour.
Despite the aggressive tightening of monetary policy by the Reserve Bank of India, or RBI, through a hike in policy rates as well as banks’ cash reserve ratio (CRR), or the money that commercial banks are required to keep with the Indian central bank, the finance ministry has all along been advising banks to offer loans at reasonable rates as high interest rate hurts the economic growth.
But, this time around, public sector bank chiefs, who control about 70% of the banking industry, didn’t want to take any chances of tempting fate and raised their lending rates aggressively—ranging between three-quarter of a percentage point to a full percentage point—even before they met Chidambaram.
State Bank of India’s benchmark prime lending rate (BPLR), or the rate at which the bank should lend to its prime borrowers, is 13.75%. The Delhi-based Punjab National Bank (PNB), the second largest public sector lender, has even a higher prime lending rate—14%.
However, despite this, these banks will find it difficult to protect their margin or the spread between the cost of funds and interest earned on such funds. This is because at least 75% of their loans are disbursed below their BPLR. And, their cost of deposits, too, is rising fast.
Most of the banks are now offering 10-10.5% interest rate on one-year deposits. Add one percentage point extra to the cost of money as banks cannot use their entire deposit portfolio to lend. They need to keep 9% of their deposits with RBI as CRR on which they do not earn any interest rate. In other words, for every Rs100 deposit, they can only use Rs91 for lending and investing in bonds even though they are paying interest on the entire sum. On top of this, there is an additional—around 2%—transaction cost, to take care of overheads and employee wages, etc. Overall, the cost of one-year money for banks is around 13-13.5%.
It is less than public sector banks’ BPLR and yet they cannot make much money on lending as they lend to very few borrowers at BPLR. Small firm loans up to Rs3 lakh—which could be as much as 10% of a bank’s lending portfolio (their agriculture loan portfolio is about 18%)—earn only 9%, inclusive of a two percentage point government subsidy. Then, bulk of the loans to exporters earns interest below BPLR. Their earnings from investment in government bonds are also less than their prime rate. For instance, yield on 364-day treasury bill is now around 9.15% and that of 10-year bond is 9.20%. Under the banking law, banks are required to invest at least 25% of their deposits in government bonds but some of them have higher bond holdings—around 30% or so.
Taking into consideration their exposure to small farm loans, exports as well as government bonds, overall, these banks earn between 9% and 10.5% on about 45% of their deposits and they do not earn anything on another 9% of deposits kept with RBI as CRR. Does that mean that on the rest—or 46% of their deposits—they earn more than what they pay to the depositors? No. They charge BPLR or more on even less than 20% of their loans. One year ago, more than 90% of their loans were priced at below BPLR.
Still, they can make money because they do not pay 10-10.5% on their entire deposit base. Banks pay high interest rate only on their term deposits or those deposits kept with them for a fixed maturity period. Beside term deposits, they also have savings and current deposits on which they do not pay high interest rates. Interest rates on savings account is now 3.5% but the actual cost for banks on such deposits is even less, at around 3% or so, as they pay interest only on the minimum balance kept between the 10th day and the last day of any month. And, on current accounts, maintained by firms and entrepreneurs, banks do not pay any interest.
Banks can ride the higher interest rate regime by pushing its low-cost current and savings deposits. The component of savings and current accounts in the overall deposit portfolio varies from bank to bank. For instance, savings and current accounts have a share of around 40% of PNB’s total deposits. In the private sector, HDFC Bank Ltd has a much higher percentage of current and savings accounts and for ICICI Bank Ltd, it’s about one-fourth of its total deposits.
Banks can garner low-cost deposits by reaching out to more and more customers in rural India. Only 59% of adult population in India has bank accounts but if one takes a look at the number of bank accounts vis-à-vis the entire population, the percentage comes down drastically to 31%. Even this is not a correct estimate as a large chunk of population in urban India has more than one bank account. This means the actual coverage is even less. In rural areas, the coverage among adult population is 39% against 60% in urban India. Indeed, the transaction cost for low-value deposits in rural India will be very high but banks can cut that by using the right technology. They can also look for more short-term float money such as dividend payout on behalf of corporations to bring down the cost of money. The best way to survive and thrive in the high interest rate regime is focusing on lost-cost liabilities and not high-yield assets.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai bureau chief of Mint. Please email comments to firstname.lastname@example.org