Subbarao asks banks to reduce margins

‘Cut operating costs, raise fee-based income to pay more on deposits, charge less from lenders’

The Reserve Bank of India (RBI) on Friday urged banks to reduce intermediation costs to increase efficiency, helping them cut lending rates, pay more on deposits and foster inclusive and higher economic growth.

The net interest margins (NIMs) of Indian banks were high compared to their counterparts in other emerging markets, even after accounting for social sector obligations, RBI Governor Duvvuri Subbarao said at the Annual Bankers’ Conference (Bancon) 2010 being held here. NIM is the difference between a bank’s income from interest-earning assets and what it pays on borrowed funds.

This is the recent occasion that RBI has commented on banks’ NIMs and emphasised the need for narrower margins. The NIMs of Indian banks range from below two per cent to more than six per cent.

Former finance minister P Chidambaram used to nudge banks to settle for lower margins. Chidambaram used to often cite the global trend of two per cent NIMs and ask Indian lenders to instead focus on increasing fee-based income. Subbarao was then at the helm of affairs in North Block.

Now, as RBI governor, Subbarao thinks the time has come for local banks to improve their operating efficiency.

“The efficiency gap between us and our peer group of countries is indicative of the catch-up job we have to do. There are several ways of improving efficiency,” Subbarao said in his inaugural speech.

“By far the most important task is to improve operating efficiency on top of what has already been achieved by optimising operating costs, that is, non-interest expenses, including wages and salaries, transaction costs and provisioning expenses. This will enable banks to lower lending rates while preserving profitability.”

The NIM of India’s banking system has fallen from three per cent in 1999-2000 to 2.5 per cent in 2009-10. Some bankers say the idea is welcome, but some challenges remain.

“In the long term, it is a laudable thought (reducing NIMs),’’ said Aditya Puri, managing director of HDFC Bank. “There are challenges in terms of delinquencies, ticket size, costs, statutory liquidity ratio, cash reserve ratio and the priority sector. Things have to settle down. The whole world is in turmoil. The rates don’t reflect the real rate of inflation, so let things stabilise.’’

Indian banks have higher earnings than those of other leading Asian economies, but they are burdened by a higher operating cost ratio, measured in terms of non-interest expenses to total assets, according to Subbarao. Higher operating costs impeded banks’ pricing efficiency and affected the ability to rationalise NIMs in a competitive manner, he added.

“The task for Indian banks, clearly, is to press on with efforts for sustainable reduction in operating costs through productivity improvement and skill enhancement and by leveraging technology,’’ he said.

“A reduction in operating costs will also come through nurturing asset quality, diligent loan restructuring of viable assets and reducing non-performing loans through recovery or upgradation.”

The RBI governor also said banks in India had not consolidated in the manner envisaged by the Narasimham (II) committee report published in 1998. The committee envisaged a three-tier structure, with three-four large banks with international presence on the top and eight to 10 mid-sized banks with branches throughout the country and engaged in universal banking in the middle. Further, the committee envisioned local banks and regional rural banks operating in the smaller regions.

“The current structure is that India has 81 scheduled commercial banks, of which 26 are public sector banks, 21 are private sector banks and 34 are foreign banks. Even a quick review will reveal that there is no segmentation in the banking structure along the lines of the Narasimham II report,” Subbarao said.