Banks waiting for cost of funds to fall: Rajan

Says delay in cuts due to wait for longer-term deposit rates to come down, as also for credit growth in general to pick up

With most banks still reluctant to cut lending rates despite the central bank having eased its prime lending rate more than once, Raghuram Rajan, governor of the Reserve Bank of India (RBI), says the lenders are waiting to first see a fall in their cost of funds.

RBI has reduced the rate at which it lends to banks by 75 basis points (0.75 per cent) since January. However, almost all banks have reduced their base rate (BR), the benchmark to which all loan rates are linked, by only 25-30 bps.

HDFC Bank, the second-largest private sector lender, is an exception. It has cut its BR by 65 bps, including a surprise 30 bps cut earlier this month.

“Mr (Deepak) Parekh's bank did pass on another 30 bps, which came as a shock to the banking system because it was an outlier in doing more," said Rajan on Friday. "Short-term deposit rates have come down but the longer term deposit rates take time to adjust.” Deepak Parekh is the chairman of Housing Development Finance Corporation, parent of HDFC Bank.

Analysts say a significant portion of HDFC Bank’s loans are fixed rate contracts. So, its margins will not be affected much due to a downward revision in BR.

“Banks are waiting for deposit rates to come down. Some of the deposits will get repriced because they are four-five year ones. As a result, their costs stay higher for longer,” Rajan said.

A rise in bad loans has already dented many banks’ profitability. It has made lenders cautious on reducing lending rates, further impacting their margins. The governor hopes if loan growth picks up, banks will start cutting lending rates, as the fall in margins will be compensated by a rise in volumes. He believes banks also await such an outcome.

“They are waiting for the credit to pick up, so that the loss on the margins is made up by the volumes of the new loans they will get. So, let us see. It is a matter of time before they pass it on,” he said.

Credit growth has been muted amid a slowing economy. Year on year, advances by banks grew 9.6 per cent till September 4. Deposits had grown 11.6 per cent.

“There is tremendous pressure on the banks from different sides that have an impact on their profitability. One has to have a little sympathy with them. The market is putting pressure, so transmission will take place,” said the RBI chief.

With banks' BR remaining high, a lot of corporate borrowers are raising their short-term requirements by issuing commercial papers.

RBI recently advised banks to consider marginal cost for calculation of the BR. This is aimed at making monetary transmission more effective.

“I think the banks that do more asset/liability management can pass it (rate cuts) on more quickly. We are trying to nudge them through regulations to move towards that. Move towards a base rate which is initially marginal cost pricing and then eventually move on to market benchmarks like the Libor (London Interbank Offer Rate). We started issuing market benchmarks through an organisation. Over time, when we sense that it is more reliable, banks will move to that,” Rajan added.