Raghuram Rajan can’t convince banks to cut rates as returns shrink

Mumbai: India’s largest lenders aren’t passing on two rounds of monetary easing to borrowers as profitability slides and bad loans surge.

State Bank of India (SBI) and Bank of Baroda are among 43 of 47 lenders yet to lower base lending rates after the Reserve Bank of India (RBI) cut its benchmark rate by 50 basis points to 7.5% in two moves this year. The three-month interbank rate has fallen only seven basis points to 8.58% in 2015. A similar gauge of funding costs in China is at 4.9%.

“So far the drop in cost of funds isn’t enough to allow us to cut lending rates,” Ranjan Dhawan, Bank of Baroda’s Mumbai-based chief executive officer, said in a 12 March phone interview. “We’re walking a thin line,” he added. “We have limited scope to cut deposit rates because competition from other savings instruments and rising equity markets is strong.”

Central bank governor Raghuram Rajan said in his 4 March policy statement that further monetary easing will need prerequisites including “the pass-through of past rate cuts into lending rates.” Union Bank of India said returns in the banking system have worsened from a seven-year low, and four of the five largest lenders reported higher soured loans in 2014.

“Banks are pressed on the profitability front more than ever before,” Arun Tiwari, Union Bank chairman and managing director, said in a 11 March phone interview. “Lending-rate cuts alone won’t spur credit growth.”

Stressed assets

Profitability, measured by the return on assets in the banking system, fell to 0.81% in the year ended March 2014, the lowest since at least 2007, RBI data show. Stressed assets, which include bad loans and restructured assets, are set to rise to 13% in the next 12 months, further eroding profitability, according to India Ratings and Research Pvt. Ltd, the local unit of Fitch Ratings.

Loans in the system grew 10.4% in the 12 months through 20 February, near the 9.7% pace in September that was the least since October 2009.

RBI has lowered the proportion of deposits banks must invest in safer assets three times since June, leaving more funds for lending to support growth in Asia’s third-largest economy. The statutory liquidity ratio (SLR) stands at 21.5%.

Banks have limited room to cut deposit rates as competing instruments such as savings plans and post office accounts are offering higher rates, according to Vibha Batra, the New Delhi-based head of financial industry ratings at Icra Ltd, the local unit of Moody’s Investors Service.

Deposit rate

SBI, the country’s largest by assets, pays 8.25% interest on five-year deposits compared with 8.5% offered by India Post and National Savings Certificates and a 31% surge in the S&P BSE Sensex Index of stocks in the past 12 months. The bank’s base lending rate, below which it can’t give loans, has been at 10% since November 2013.

The International Monetary Fund (IMF) estimates it takes 13 months for 80% of the change in the RBI’s benchmark rate to pass-through to interbank funding costs, according to an 11 March report by the Washington-based lender. Transmission to banks’ deposit and lending rates takes another 9.5 months and 18.8 months, respectively, IMF said.

“Most banks may cut lending rates in the September quarter,” Hatim Broachwala, a banking analyst at Nirmal Bang Institutional Equities Ltd in Mumbai, said by phone on 13 March. “Credit demand is also expected to improve by then.”

Capital adequacy

The average capital-adequacy ratio for Indian lenders fell 20 basis points, or 0.2 percentage point, to 12.8% in the six months ended 30 September, central bank figures show.

The cost of insuring SBI’s bonds against non-payment for five years using credit-default swaps has climbed to 146 basis points from 143 on 5 March, the lowest since April 2010, according to data provider CMA. Similar contracts for ICICI Bank Ltd have risen 1 basis point to 158 in that period.

The yield on India’s 8.4% sovereign notes due July 2024 rose 9 basis point to 7.8% last week according to prices from the RBI’s trading system. The rupee fell 1.25% to 62.9650 a dollar.

“Rising bad loans and lower demand for credit are putting many lenders under phenomenal pressure to improve retained earnings and bolster capital ratios,” Batra from Icra said by phone on 13 March. “So they may be forced to defer a cut in lending rates till the credit environment improves and the pressure on earnings ease.” Bloomberg