Lazy banking or easy banking?

In the first quarter of fiscal 2013 (till 15 June), banks in India invested a little more than ₹ 30 in government bonds out of every ₹ 100 they had in deposits. Under the central bank’s norms, banks are required to invest ₹ 24 for every ₹ 100 deposits they raise, but they are investing much more. It is not because they love to invest in government bonds that are being sold in the market to bridge the deficit, but the investment in sovereign bonds is risk-free and they prefer this when bad loans for most banks have been rising.

An increase in bad loans hurts banks. They do not earn any interest on such loans. And, on top of that, they need to set aside money for bad loans. A good part of those loans which were restructured in the wake of the fall of US investment bank Lehman Brothers Holdings Inc. and the unprecedented global credit crunch is turning bad, and this is making banks reluctant to give fresh loans.

By simple arithmetic, bad loans as a percentage of total loans will rise if banks are not giving fresh loans.

The trend is similar when it comes to banks’ exposure to non-banking financial companies and commercial real estate. In the first segment, credit growth is down from 54.4% to 41%; and in the latter, from close to 20% to 2.8%.

In past few years, the bulk of bank loans has been flowing to the infrastructure sector; but that is almost drying now. The growth in infrastructure loans in May has been 13.3%, against 38.7% in May 2011, and 44.3% in May 2010.

The most affected sectors within infrastructure are power and telecom. Loan growth to the power sector in May has been 13.7%, down from 42.4% a year earlier, and 55.6% in 2010. Loan growth to the telecom sector actually declined (-0.1%) in May against 63.7% last year, and close to 35% in 2010.

Banks are not giving loans for fear of rising bad assets. That is one part of the story. The other part is: the companies are finding the cost of money too high.

HDFC Bank Ltd recently cut its base rate, or minimum loan rate, by 20 basis points to 9.8% from 10%; but no other bank has brought down its base rate even though many of them are paring the actual loan rates to sectors such as agriculture and small and medium enterprises. One basis point is one-hundredth of a percentage point.

In April, after RBI surprised the market with a half-a-percentage point cut in the policy rate, sending a strong signal to banks to cut loan and deposit rates, ICICI Bank Ltd, IDBI Bank Ltd and Punjab National Bank cut their base rates marginally; but most banks have been tweaking their loan rates for different business segments, leaving the base rate untouched. This makes the base rate irrelevant as this is the benchmark for all loan rates.

RBI had forced banks to replace the erstwhile prime lending rate with the base rate as the prime rate became irrelevant with banks giving a bulk of the loans at below that rate. In some sense, the base rate is also going the same way.

Banks are expected to consider various factors, including cost of funds and bad assets, to fix the base rate, and all loans rates need to be linked to the base rate. This means, without changing the base rate, banks cannot change any loan rate.

But they are doing so, for certain loans, by shrinking the margin or the spread. How can they do it if the cost of funds remains the same? It is clear now that they were enjoying too fat a margin for loans to certain segments, which they are cutting down now. By the same logic, they can increase the margin and raise the loan rates without changing their base rates. They are just not transparent in their dealings with the borrowers.

The cost of funds will not come down as banks are not paring their deposit rates. Most banks are offering around 9% interest for deposits maturing in one year and above. They offer more for bulk deposits. This is when the yield on government bonds are coming down. For instance, the benchmark 10-year bond yield was 8.55% in March-end; now it has come down to around 8.15%. Similarly, the short-term three-month commercial paper rate was 11.26% in March-end; it is now 9.36%.

There are two reasons behind the fall: first, the market expects RBI to cut its policy rate and, second, the cash deficit in the system has come down from a daily average deficit of ₹ 1.36 trillion between January and March to about ₹ 90,300 crore since April. While the market rates have come down, banks have not pared their base rates as they are still paying relatively high rates to their depositors.

The government has raised about 35% of its annual ₹ 5.7 trillion market borrowing programme in fiscal 2013 to bridge an estimated 5.1% fiscal deficit. After taking into consideration the redemption of old bonds during the year, the net borrowing will be ₹ 4.79 trillion, about ₹ 44,000 crore more than what the government had borrowed last year. The banks seem to be happy investing in bonds even though they are paying more for deposits than what they are earning from such investments. A classic case of lazy banking. Or, should we say, easy banking?

Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Email your comments to bankerstrust@livemint.com