Lower deposit rate: A result of poor credit and strong deposit growth

Banks are choosing government securities and retail loans over corporate loans

Three private sector banks HDFC Bank, ICICI Bank and Axis Bank have together announced a cut in deposit rates on September 12, 2012. State Bank of India was the first bank to reduce deposit rates last week. Nothing from the central bank by way of a base rate reduction has prompted these banks to do so.

The reduction in deposit rate indicates that banks are flush with funds and are discouraging deposits. This fact is also visible in LAF (Liquidity Adjustment Facility) numbers. LAF allows banks to borrow through repurchase agreements to meet their day-to-day mismatches in liquidity. A lower LAF indicates banks do not need to borrow and have sufficient liquidity.

Ashish Parthasarthy of HDFC Bank in an interview on CNBC said that short term rates of certificates of deposits (CDs) and commercial papers (CP) have come off and trade near their year’s low again indicating enough money in the system. Along with this deposit growth in the month of August was higher while loan disbursals fell short of target.

Though the central bank has not reduced interest rates, money is available in the system at lower rates for quality borrowers. But that is where the problem lies. The current slowdown has resulted in fewer corporates qualifying for availing loans.

In an article in DNA, Arjun Parthasarthy said that banks are lending just 9.5 paise for every rupee of deposit raised.

Since March 2012, deposits have increased by Rs 1.79 lakh crore while credit has increased by only Rs 17,000 crore. Banks have preferred investing in government bonds rather than lend to companies. Banks’ investment in government bonds has touched Rs 1.80 lakh crore during the same period.

Rising non-performing assets is naturally preventing banks from lending in the market. Private sector banks prefer personal banking by lending to individuals as personal loans, vehicle loans or home loans rather than giving the money to the corporate sector.

These developments suggest that in the present quarter, banks’ profit from treasury income is expected to shoot up and so will fee-based incomes, which they collect on account of various charges from personal banking. Lower deposit rates will also result in lower cost of funds, thus improving their net interest margins (NIM).

As for lending to the corporate sector, unless confidence is restored in the system, RBI’s tweaking with interest rates is unlikely to result in credit growth. Confidence restoration is the job of the government and we all know how well they are performing it.