What Reserve Bank of India (RBI) governor D. Subbarao could not do through a series of rate cuts, India\u2019s finance minister P. Chidambaram now wants to achieve through a gentle nudge. Bank of India announced a cut in its base rate or the minimum lending rate on Wednesday by 25 basis points (bps). Other banks, barring the nation\u2019s largest lender State Bank of India, are expected to follow suit. One basis point is one-hundredth of a percentage point.
\nAfter the cut, Bank of India\u2019s base rate will be 10%. SBI\u2019s base rate is 9.7%.
\nBank of India cut its loan rate after Chidambaram asked state-run banks to lower their minimum lending rate and disburse more loans to stimulate growth in Asia\u2019s third-largest economy.
\nSubbarao has been cutting rates with the same intention, but banks have not been listening to the regulator.
\nSince January, RBI has cut its policy rate by 75 bps, but banks have cut their loan rates only by about one-third of that.
\nIn fiscal 2013, RBI had cut its policy rate by 100 bps, but the average loan rate reduction by banks\u2019 was 36 bps. The reason? Banks could cut their deposit rates by just 11 bps points. If they cannot bring down their deposit rates, how will they pare their loan rates?
\nThe logic is flawless, but this makes it pretty clear that RBI has failed in monetary transmission. And that the gap between the loan market and bond market in India is getting wider. When RBI cuts its policy rate, only the bond market reacts; the loan market remains insulated. A look at how the 10-year benchmark bond yield has moved in the past one year and the trajectory of banks\u2019 loan rate proves that. The government is the biggest beneficiary of policy rate cuts and companies hardly get any benefit.
\nBanks have been clamouring for a cut in their cash reserve ratio (CRR) or the portion of deposits that they keep with RBI. They say this will help them cut their loan rates. Their logic is that they do not earn any interest on CRR and once RBI brings it down, the money thus get freed will earn interest for them and that earning can offset the impact of a rate cut.
\nIf we accept that logic, there is hardly any possibility of companies seeing loan rates going down. The CRR is currently pegged at 4%. Theoretically it can go to zero, but no prudent central banker will do that. One might see a 100 bps cut in CRR over a period of time.
\nDoes that mean that the banks will continue to charge high rates to corporate and individual borrowers? The answer is yes. Companies will have to pay for the inefficiency of the banking system, the inability of their peers to pay back bank loans, and RBI\u2019s failure in monetary transmission\u2014and not necessarily in this order.
\nIn October 2011, when RBI freed the rates of savings bank account, the last bastion of administered rate in Indian banking system, expectations were high that banks would respond to this cry of freedom, but they decided to play safe. Barring a handful of new private banks\u2014Yes Bank Ltd, Kotak Mahindra Bank Ltd and IndusInd Bank Ltd\u2014no bank tinkered with the savings rate.
\nThese three raised their savings bank rate, while others continue to pay 4%. One can appreciate the fact that they did not want to wage a rate war, but what prevents them from cutting the savings bank rate now when inflation is low?
\nFor the record, in October 2011, wholesale inflation was 9.87% and the non-food, non-oil, manufacturing inflation or the so-called core inflation was 8.13%. In May, wholesale inflation dropped to 4.7% and core inflation 2.43%. If the savings bank rate continues to remain at the October 2011 level, how can we expect to see monetary transmission?
\nDid I hear someone say lazy banking?
\nBanks cannot bring down their loan rates because they all believe in status quo. And they are grappling with bad assets. Bad assets are a double-edged sword. Banks do not earn on such assets and on top of that they need to set aside money for them. After doing that, they are not left with anything that can be passed on to the borrowers.
\nEven if Subbarao brings down the policy rate to zero, our banks will not be able to cut their loan rates substantially. The regulator has failed to push them. Let\u2019s see whether their majority owner succeeds.<\/p>\n","protected":false},"excerpt":{"rendered":"
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