Why bankers didn't want RBI to cut interest rates

A further cut might have forced them to cut base rate, putting pressure on their margins amid rising NPAs

Over the past week, whenever a banker was asked by a reporter when his/her bank was expected to announce a cut in the lending rate – something that has been long awaited – the standard answer was “let’s wait till the RBI policy”.

It is not that expectations from the monetary policy were divided. An overwhelming majority of bankers expected the Reserve Bank of India not to cut interest rates. The central bank has reduced the policy rate or the repo rate by a total of 50 basis points since January. However, barring a couple, no bank has reduced base rate – the benchmark to which all loan rates are fixed. One basis point is one-hundredth of a percentage point.

At a press conference on Monday, Dena Bank Chairman & Managing Director Ashwani Kumar had echoed the view of many of his colleagues: "I do not expect an interest rate cut in the policy to be announced on April 7.”

Banks' reluctance to reduce interest rate – which puts the entire monetary transmission process in jeopardy – is not new, though.

A recent report by Deutsche Bank economists cites the example of the last repo rate easing cycle. "In the last easing cycle (April 2012-June 2013), a 125-bp cut in the repo rate, along with a 75-bp one in CRR (200-bp cut if the period is extended from Jan 2012-June 2013) led to banks’ base rate reduction of just 50 bps!”

But why are banks not cutting rates? Conventional demand-supply theory will suggest that banks should cut the price to boost their product sales – since sales are at a 20-year low. Loan growth was 9.65% year-on-year till March 20, the slowest in two decades. It has come down significantly from the previous year, when growth was 14%. Additionally, the first few months of the financial year are known as the ‘slack season’, meaning credit demand is muted. Still, there is no effort to revise pricing to boost sales.

Bankers said a mere 25-bp base rate cut would not revive loan demand – particularly by the corporate sector, which is availing of funds from commercial papers where rates are hovering around 9%. They would continue to issue CPs for their working capital needs as the base rate was 10% or more, so a 25-bp rate cut would not help, bankers said.

Also, a reduction in the base rate would also put their margins under further pressure. Net interest margins are bleeding mainly due to a rise in non-performing assets, particularly for public-sector banks, as a growing number of assets is not earning any revenue.

But a further rate cut by RBI would have put banks under immense pressure to pare their lending rates, which the banks did not want at this point.
(Manojit Saha is Banking Editor at Business Standard)