Lower rates unlikely to translate into higher demand for bank credit

Borrowers may continue to wait hoping for rates to fall further

A 25-basis-point repo rate cut might not lead to an immediate improvement in demand, as corporate houses are unlikely to rush to borrow money from banks or non-banking sources. Financing options from non-banking sources have become even more inexpensive.

According to Bloomberg data, the interest rate on commercial paper in the secondary market for tenure of one month to 12 months range between 8.39 and 8.85 per cent, over 100 basis points lower than what banks have been lending at.

As a result, even if banks cut their lending rates by 25 bps in accordance with the repo rate cut, lending via the money market route will still be cheaper for companies.

“Even if banks cut their base rates, the rates in the money market might also come down, as the money market is not a constant thing and yields have already started coming down. Therefore, a rate cut will not mean that credit offtake will increase in the short term,” said P Sitaram, CFO, IDBI Bank.

Credit demand has been decelerating and loans grew at its slowest pace in a decade in September 2014. According to the Reserve Bank of India’s latest data, the year-on-year growth in bank credit was 10.5 per cent as on December 26.

“… Transmission of Thursday’s rate cut beyond the near term – after a proportionate reduction in lending rates by most banks -- would hinge upon the risk aversion among banks because liquidity is expected to remain comfortable. As to whether this will trigger credit growth immediately, the jury is out because interest rates in the money market are already 100-150 bps lower than bank lending rates,” said a CRISIL report. It is not only the corporate borrower. Even the retail borrowers are likely to stay away, in anticipation of a further rate cut.

“Now that the rate cut cycle has begun, borrowers, especially individual ones, will wait in anticipation of a further rate cut. Retail borrowers are typically choosy and if they know that can get a lower rate of interest after a few months, they will normally postpone  purchases. Therefore, it is unlikely credit demand will improve immediately,” P Srinivas, managing director and chief executive officer of United Bank of India (UBI), told Business Standard.

UBI was the first bank to lower its base rate after RBI cut the repo rate on Thursday. This was the first repo rate cut since May 2013. India Inc has been demanding a rate cut, claiming   it was essential to propel investment demand. UBI, Union Bank of India has also announced a reduction in base rate. Many other banks are expected to mirror the move in the coming days.

"RBI's stance signifies that if other conditions do not become adverse then the rate cut journey will continue. But it has to be established at what rate the investors' confidence in building capacities and expand capital expenditure will actually happen," said Ashvin Parekh, managing partner at Ashvin Parekh Advisory Services.

Moreover, bankers and industry experts also stress on the fact that credit offtake will not improve until green shoots in the economy become more visible.

"Credit demand is a function of a multitude of factors apart from just the cost of capital. First, while some banks have cut their base rate, a cut in the repo rate by RBI would not necessarily translate into rate cuts by other banks as they would individually assess their asset and liability situation. Second, lower rates would take time to filter through the supply chain, which further depends on the efficiency of the transmission mechanism. Overall, we see this cut in rate by RBI coming in at an opportune time, but we believe that it would take some time for it to have a perceptible impact on credit offtake," said Anis Chakravarty, senior director at Deloitte in India.

Bankers also felt that a 25-basis-point rate cut might not be adequate to rebuild investors' confidence and revive capital investments.

"Lower interest rate is just one ingredient in the credit demand cycle. A lower rate will help in boosting sentiment but credit offtake will depend on investment appetite of large corporate borrowers and incremental investment opportunities. So, for credit demand to improve the economy has to pick-up and a 25-basis-point rate cut is probably not enough for that," said Shyam Srinivasan, managing director and chief executive officer of Federal Bank.