Interest rates have become a bone of contention between thebanks and their regulator, the Reserve Bank of India (RBI). The central bank inits Monetary Policy Committee (MPC) meeting held on February 7, 2019 had cutthe repo rate by 25 basis points to 6.25%, the banks, except a few, didn’ttransmit the benefit of this rate cut to its borrowers. The RBI GovernorShaktikanta Das had even met bankers last month to nudge them to cut interest rateafter conceding that monetary policy transmission is a concern for the apexbank.
The cut in the policy rate had raised hopes of the millionsof home loan and consumer loan borrowers to see their equated monthly instalments (EMIs) reduced bytheir respective banks. However, the bankers showed reluctance to pass on thebenefits of the rate cut. They conveyed to the regulator that the deposit ratesremain elevated and the liquidity situation tight.
Why banks have been reluctant to lower interest rates on loans when the apex bank loosened its policy (repo) rate? The banks are not getting sufficient deposits. At the moment, deposits and household financial savings are at historical low.
The government is playing its own game against the banks. It offers savings schemes through post offices to the public at significantly higher rates than the bank deposit rates. Besides, the depositors are extended tax saving benefits on deposits in post offices. This policy has adversely impacted the deposit growth of banks. Comparatively, it’s growing at a slower pace than loans.
Notably, the RBI data reveals that ‘bank lending has beengrowing at more than 14 percent year-on-year as of February, while depositgrowth has been a laggard at 10 percent.’ So, under the given circumstances,the banks are forced to offer higher rates to lure depositors and build uptheir resources to lend.
In absence of resources to lend, the only way to mobilizedeposits is not to cut but to offer attractive rate of interest. It’s here thebanks are forced not to fall in line with the policy rate cut and finallyhampers monetary policy transmission. In a way, we can measure this situationas a financial crisis for the banks.
In other words, we can sum up that banks are confronting amismatch between deposits and credit growth. Government backed offerings ofpost offices, where depositors are lured though higher rate of interest ondeposits than the bank deposit rate, are giving a tough competition to thebanks. Thus, limiting the ability of banks to transmit the convenience ofmonetary policy.
In order to come out of this situation, the banks direlyneed fresh deposits. And the only way to attract fresh deposits is either tocontinue maintaining interest rates at their current levels or raise them.Hence, the banks are clearly not in a position to cut the interest on depositrates.
Here it’s worth mentioning that the bad situation in which banks are gripped has also its roots in demonetization, It proved a demon for the banks as this too played havoc with their deposits. It shattered trust between banks and the people.
The people started preferring mutual funds to bank deposit schemes. Over a period of time, this created a deposit shortage for banks. Now, the return of depositors to banks depends upon the performance of stock market.
For instance, if the stock market fails them to get decent return on their investment, chances are that the investor will have a relook at the option of bank deposit schemes. However, the shift under those circumstances would take its own time.
To be precise, the banks’ poor response to recent rate cut has already put pressure on the monetary authority to further loosen policy so that economic growth is pushed up.
If the RBI announces another round of rate cut in its meeting to be held on April 5, possibility is that the banks would be experiencing the heat. They would be forced to fall in line by lowering interest rates on loans.
Meanwhile, the RBI can create a win-win situation by cuttingthe cash reserve ratio (CRR) from the current level of 4%. This will help topump a lot of money in the financial system and banks will be forced to cutinterest rates.
(The views are of the author and not that of the institutionhe works for)