Faulty transmission

Indian banks stuck in a monetary trap

India's banks are stuck in a monetary trap. The Reserve Bank of India's interest rate cut on March 19 should enable them to offer cheaper loans to customers, helping spur the economy. Instead, they have little choice but to keep the benefit for themselves.

Banks need all the income they can get to keep depositors. Growth in savings is already failing to keep pace with lending. Deposits have grown an anaemic 14 per cent over the past year, according to central bank data. That's below the 17 per cent growth in loans, which has slowed down from 20 per cent a year earlier.

Not only can't banks pay depositors less on their savings - they ought to be paying more. With inflation at an annual 11 per cent in February, small savers earn a real interest rate of minus 4.5 per cent on money parked for up to a year at the State Bank of India, the largest state-owned bank. Depositors thus face what amounts to a raid on their savings.

Lenders still make a positive, if diminishing, spread between loans and deposits - 3.4 per cent between April and December 2012 for the State Bank. But there are other claims on that margin, like laying aside provisions for bad debts. Net non-performing assets of publicly traded lenders surged to Rs 92,400 crore ($17 billion) in the quarter ended December 31, a 50 percent jump in just nine months, according to NPAsource.com.

There are two ways out of the trap. One is to address the bad debts, by recapitalising the state-controlled banks. A Rs 14,000-crore ($2.6 billion) equity infusion was promised in the February 28 budget, but it is far from enough. Even without an increase in bad loans, the government needs to find Rs 1.5 lakh crore by 2018 to prepare them for the new Basel III bank rules. The other way is to take a firmer grip on consumer prices, so that negative deposit rates turn positive.

With a broken credit channel, it's harder to revive GDP growth, which was just 4.5 per cent in the December quarter. Until the banks are working properly, rate cuts from the RBI seem like throwing good money after bad.