Reforms Help Partial Recovery Of Spreads

Higher levels of productivity, improvement in spreads, recapitalisation, and realignment of credit-deposit ratio underscored banking sector performance during 1991-96. Has the initial phase of

turbulence marking banking sector reforms been replaced by a spell of consolidation? An analysis of the Indian Banking Data 1991-96 compiled by the Indian Banks Association.

The banking sector has made a partial recovery in the spreads since the beginning of the reforms process.

However, the spreads (as a percentage of working funds) have gone down in the period 1991-92 to 1995-96, from 3.31 per cent to 3.15 per cent.

During the start of the reform process, there was a steep fall in the spreads. But, the past couple of years have witnessed the spreads recovering impressively.

 

Accordingly, the spreads for the 91 banks under consideration fell from 3.31 per cent in 1991-92 to 2.51 per cent in 1992-93 and recovered to 3.15 per cent by 1995-96.

The net profits for the banking sector as a whole slipped from Rs 1,313 crore to Rs 861 crore during this period. However, in the first two years of reforms, that is in 1992-93 and 1993-94, the banks posted a net loss of Rs 4,131 crore and Rs 3,715 crore respectively. The net loss was mainly on account of the losses posted by a few nationalised banks owing to the revised provisioning norms and improved accounting standards.

"The initial fall in the spreads can be explained by the stricter provisioning and prudential norms. Later, the flexibility with respect to interest rates on the lending side would have helped in the spreads recovering," said Bandi Ram Prasad, chief economist, Indian Banks' Association. In the case of State Bank of India, the spreads had declined from 3.63 in 1991-92 to 3.48 per cent.

While for the 27 public sector banks the spreads have gone down from 3.22 at the beginning of the reform process to 3.10 per cent, in the case of private banks this ratio has slid from 4.01 per cent to 3.10 per cent.

As regards the foreign banks, the spreads recovered from 3.56 per cent in 1992-93 to 4.25 per cent in 1994-95.

The spreads, however, came down to 3.76 per cent in 1995-96 due to higher cost of funds. In September-October 1995, the rupee had depreciated against the dollar, while the forward premiums had skyrocketed to over 20 per cent, thereby increasing the cost of non-resident deposits in case of the foreign banks. In case of banks with a retail domestic presence, viz Hongkong Bank, ANZ Grindlays, Citibank, Standard Chartered, the impact was much less.

The rise in the cost of funds and the intensifying of the competition could well ensure that the spreads do not recover to the levels that existed at the beginning of the reforms process.

In 1996-97, the spreads could come down further due to higher cost of funds and the insistence by RBI that the banks specify a maximum spread over their prime lending rate.