Case Strong For A Deposit Rate Cut

Should deposit rates be reduced further with margins of banks under pressure?

Anil K Khandelwal

ED, Bank of Baroda

There is a strong case for bringing down deposit rates further to reduce the cost of funds notwithstanding that a 3 per cent cut had already been affected during the course of last one year.

Considering that commercial paper, repo and call money rates are hovering around 5.5-6 per cent, banks are facing the risk of negative spread unless interest rate on deposits was cut. A case for cut also exists when viewed against the higher real interest rate.

Due to lower inflation ranging between 1.5 and 3 per cent if measured on the basis of wholesale price index, and between 5 and 6 per cent in the case of consumer price index, real interest rates continue to remain higher.

 

The financial sector, including banks, is saddled with more than Rs 110,000 crore of non-performing assets, and there is a lot of liquidity overhang with limited scope to invest due to various restrictions. Under the circumstances, banks do not have any recourse but to effect a cut in their deposit rates to improve their bottom line.

It becomes necessary to take a view on some fundamental issues when it comes to examining whether any cut in the lending rate (owing to either a reduction in the deposit rate or bank rate), or injecting further liquidity by reducing the cash reserve ratio would help in accelerating the pace of credit offtake.

Any cut in the lending rate can lead to higher credit offtake, if marginal efficiency of capital (future expectations about profit) in the economy is high and large industries are going to banks to meet their credit requirements. Unfortunately, this is not happening due to a variety of reasons.

Banks have already been facing a disintermediation problem. Thus, unless the credit absorption capacity of the economy is increased or exports pick up it is difficult to conclude at this juncture whether a cut in interest rate will lead to an acceleration of credit growth.

What is the solution, then? It obviously lies in stimulating aggregate demand in the economy. Banks alone cannot play a crucial role here. This can possibly be achieved through massive infrastructure financing. But this is easier said than done, because the Dabhol imbroglio, the lukewarm response from private sector to infrastructure is pointers to the constraints on this score.

Unless some mechanism to ensure a fair return on such long-term financing is assured through, such as by some fine-tuning of schemes, the private sector may not come forward for such long-term financing. Irrespective of the economic considerations, there are certain social compulsions too which should not lose our sight in the realm of further cut in interest rates on deposits.

Deposit rates cuts do have social implications too for Indian economy where unlike developed countries no safety net is available for populace at large especially those living below the poverty line and are not gainfully employed.

As a banker, I would say there is a definite need for cutting rates to save banks from getting financially weaker at a time when they are bracing for competition and are saddled with lot of sticky assets.

CRR and bank rate cuts pivotal

Chanda Kochhar

ED, ICICI Bank

All of us have seen days when money in bank deposits used to