A cut in time

Sharp reduction in lending rates can help kick-start credit growth

Banks have started cutting lending rates aggressively after a massive inflow of deposits spurred by the demonetisation of high-value banknotes led to a significant reduction in their cost of funds. According to the latest Reserve Bank of India (RBI) data, bank deposits surged by 15.9 per cent year-on-year (YoY) till December 9, up from 10.9 per cent a year ago. As a result, a CLSA report reckons the incremental cost of new deposits is 3.5-4 per cent. And contrary to concerns expressed in certain quarters that these low-cost funds may go out of the banking system as soon as withdrawal curbs are lifted, State Bank of India (SBI) Chairperson Arundhati Bhattacharya said on Monday that she expected 40 per cent of this money to stay with the bank for quite some time.

The lending rate cuts followed Prime Minister Narendra Modi’s address to the nation on New Year’s Eve, exhorting banks to “keep the poor, the lower middle class, and the middle class at the focus of their activities” and to act in the “public interest”. Reduced lending rates in the backdrop of an interest rate subvention for a few segments can potentially kick-start credit and economic growth. In any case, with large corporate credit growth slowing significantly over the past two years, measures aimed at stoking demand in lower-ticket size lending makes sense.

The move by banks is also welcome in view of the sluggish transmission of monetary policy so far. For instance, before cutting its lending rate by 90 basis points on Sunday, SBI had reduced its lending rates by just 110 basis points since January 2015, even when the repo rate, over the same period, was reduced by 175 basis points. This slow transmission of monetary policy essentially made it costly for new business activity to obtain cheap credit despite falling inflation and decelerating economic growth in the country. 

Not surprisingly, private investments have been contracting in all the three quarters for which data is available in the 2016 calendar year. As a result, credit off-take plummeted. According to the RBI, credit expanded by 5.8 per cent YoY till December 9, 2016, down from 10.6 per cent a year ago. Under the circumstances, when they are flooded with money, banks are better off cutting rates and looking at funding economic activity instead of earning just about six per cent by investing in government bonds. While this will have a salutary effect on the economy overall, savers may have to contend with lower returns as deposit rates are likely to fall as well in line with the cuts in lending rates.

Banks should, however, approach the next round of lending without compromising on prudential norms. That is because the level of non-performing assets in the system continues to pose a threat, and the health of several banks, especially in the public sector, continues to be weak. The latest financial stability report by the RBI states that the GNPA (gross non-performing advances) ratio of scheduled commercial banks increased to 9.1 per cent in September from 7.8 per cent in March, pushing the overall stressed advances ratio to 12.3 per cent from 11.5 per cent. It is true that part of the reason why these ratios are worsening is because the RBI had tweaked the recognition norms in late 2015. The central bank had mandated that all banks clean up their balance sheets by March 2017. But beyond that there are continuing concerns about which projects will be able to respond favourably to the uncertain economic climate. As such, fresh lending should not be without adequate sagacity.