Hiking deposit rates

Banks should have policy and operational autonomy

How should one interpret the hike in deposit rates announced recently by SBI and a few other banks? Does it simply reflect the acuteness of the cash crunch in the money market with banks borrowing more than Rs 100,000 crore from RBI? Or was it, instead, a quick response to the counsel offered by the RBI governor to offer higher rates on deposits and charge lower rates for loans? Bank stocks have sold off since Monday with the stock market apparently under the impression that the governor’s advice was more in the nature of a diktat. The market fears that if banks were to kowtow to the governor’s wishes, they could have to live with a permanent dent in their profitability. However, markets are known to over-react to any suggestion, however innocent or innocuous, of a strain in bottom lines and perhaps this was no exception. It is quite likely that the banks essentially responded to the severe liquidity crunch in the market that set in from September and shows little sign of abating despite RBI’s best efforts to infuse cash. It is also likely that if banks, like any other commercial entity, are interested in maximising profit margins, lending rate increases are likely to follow to preserve interest margins. In fact, mortgage giant HDFC and ICICI Bank increased their benchmark lending rates on Saturday last and Punjab National Bank raised its rate on Tuesday. If SBI, the industry leader, also hikes, it could set the stage for loan rate hikes across the board. The consensus in the markets appears to be that the liquidity shortage is unlikely to disappear in a hurry. Thus, deposit and lending rates could move up some more in the next few months.

But can banks ignore the central bank governor’s advice altogether? One hopes that they can, at least in the near term, and the governor’s statement was nothing more than “friendly” advice that is unlikely to be enforced. For one, despite a couple of decades of financial liberalisation, banks continued to be fettered by various norms. Forty per cent of lending is “directed” by RBI to the priority sector and the government impounds 20 paise of every rupee deposited with banks through the statutory liquidity ratio (SLR). It is imperative that banks are allowed to retain some autonomy in determining deposit and lending rates that are key to their profitability. The Indian credit markets are competitive enough for changes in market conditions to translate into changes in deposit and lending rates. The central bank has its set of tools like the repo and reverse repo rates, and the CRR to signal its “stance” on interest rates and it should be left to banks to take their cues depending on their reading of market conditions. Any regulatory interference beyond this is entirely unwarranted in a sector that has no dearth of competition, at least in pricing. In the longer term, some “structural” compression of margins is perhaps possible if banks can increase their operating efficiency. However, to expect public sector banks to do this without increasing their operational autonomy (trimming their workforce for instance) would be both unrealistic and unfair.