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"Will banks now start lending more?"

April 29, 2009 10:28 IST
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Banks may reduce interest rates in keeping with the RBI's rate cuts, but they are unlikely to lend more till corporate balance sheets start looking healthier.

JM Garg
Chairman and Managing Director, Corporation Bank

'Banks will cut their PLR again next month, and by September, lending rates will be down to around 11%'

The Reserve Bank of India's (RBI) decision to reduce the repo and reverse repo rates by 25 basis points each is a clear signal to lower both lending and deposit rates. Today, there is huge liquidity in the system with over Rs 1,00,000 crore parked by banks through the reverse repo route.

With the economy slowing down, credit off-take has also been slowing down. The economy is expected to grow at a slower pace than it did last year and the first half, in particular, will be very sluggish. Things could, however, pick up in the second half, depending upon how the global economy and world markets behave. So, interest rates will definitely come down.

In April, banks reduced their Prime Lending Rate (PLR) and they will be cutting their PLR again in May. This will start with a 25-50 basis point reduction. Deposits rates will also come down substantially. Bulk deposit rates for one year are already down to almost 5.5 per cent as compared to around 12 per cent during October-November 2008.

Also, inflation based on the Wholesale Price Index (WPI) has dropped to 0.26 per cent and it is expected that, by the end of the year, it will stabilise at around 4 per cent. The expectation is that Consumer Price Inflation (CPI) will also moderate as food prices start falling on the back of a normal monsoon.

The real interest rate is normally 2 per cent above the average inflation and this ensures deposits get positive returns. So, as it happened in the period between 2003 and 2005, banks will gradually bring down the interest rates and, by September, deposit rates should be around 7 per cent - lending rates will be around 11 per cent, provided inflation remains stable.

At these levels, banks will be able to maintain their margins and remain profitable. There may, however, be some pressure on banks which have raised deposits with higher maturity periods of more than 300 days - especially the 500- and 1,000-day deposits - at high interest rates of 10-15 per cent. In their case, the cost of deposits will be an issue. But many banks are like us, where the average deposit term is seven months or so, which allows us to re-price our loans after a short period of time.

Some banks are talking of the 8 per cent interest rate paid on various small savings schemes as something which prevents them from reducing deposit rates. But looking at what's happened over the past few years, it should not be a problem.

First, liquidity is one of the main reasons why bank deposits are preferred. Then there is the issue of convenience, since you can deposit and withdraw money in/from a bank any time you like. In case of the small savings schemes, this is not possible. There is a possibility that, to remain competitive, banks may also have to keep rates for 5 year-deposits at above 8 per cent. But this is a small component of the total deposits.

While public sector banks have been lending, there is an issue of demand for loans which is linked to the growth of the economy. If the economy grows at 6 per cent, the demand will be lower than what it was when the GDP growth rate was 9 per cent.

(As told to Sidhartha)

J Moses Harding
Head - Global Markets Group, IndusInd Bank

'The system must have enough liquidity and ways have to be found to help banks partially offload their credit risk'

Interest rates and yields across most products - deposits, advances and bonds - as well as across different tenors are significantly lower than they were in October-December 2008. There was a considerable lag in the RBI's monetary measures (cut in policy rates as well as cuts in statutory reserve ratios) getting translated into lower interest rates.

Also, what could not be achieved through a cut in policy rates was achieved through an overhang in liquidity in the system and subdued credit demand. It is also not correct to study interest rate moves by looking at just the Prime Lending Rate (PLR) which is, increasingly, becoming less relevant since most corporate lending is done at sub-PLR and many loan products are de-linked from PLR.

The issue that concerns the RBI is to try and get banks to stop using the reverse repo window and, instead, lend to productive as well as sensitive sectors. There is a lot of liquidity with around Rs 1,00,000 crore (Rs 1 trillion) of average daily flows to the RBI at the reverse repo rate (currently 3.25 per cent), and more funds remaining un-availed at its repo counter (where the rate is currently 4.75 per cent).

This liquidity overhang has pushed the Mumbai Inter Bank Offer Rate (Mibor) and commercial deposit rates significantly down, leading to a huge squeeze in credit premium for bank risk. The same thing is happening in the case of corporate entities which are able to borrow at much lower rates - lower than the deposit rates of many banks.

The global economic slowdown has resulted in reduced consumer demand, leading to sub-optimal production capacity in the economy. This has resulted in reduced demand for bank credit from borrowers with acceptable credit risk.

It is obvious that borrowers with higher credit risk, who are more vulnerable to the economic slowdown, are feeling the heat. Thus, we need to find ways and means to direct the flow of credit to these critical sectors at affordable costs, after factoring in the appropriate credit-risk premium.

Making lenders more comfortable about lending to high-risk borrowers can be done in two ways: By maintaining abundant system liquidity with lower base costs; by enabling banks to offload their credit risk, either wholly or partly, to entities who have the risk appetite.

It is expected that the current excess system liquidity is a short-term phenomenon, and higher market borrowing by the government is bound to put pressure on interest rates in the medium-term. Hence, there will be a need to cut policy rates and statutory reserves as well as to infuse liquidity through LAF/refinance.

More importantly, participation of financial institutions (FIs) is essential to support lenders in de-risking credit default. This can be done through non-funded risk-participation by FIs which would enable lenders to price credit with minimal risk premium.

The regulator should now extend the benefits (of interest cost reduction) from good-risk borrowers to others who are of systemic importance but carry higher credit risk. What is critical is not the availability of liquidity at an affordable cost, but shifting the direction of flow of credit to productive and economically sensitive sectors!
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