Win For The Markets

It is still too early to rejoice that banks are beginning to read market signals properly. Perhaps the first reaction of most bankers to lending rate cuts is that they will cut back on deposit rates also. They could be making a costly mistake. For, as has happened on the lending side, market forces will make certain that banks do not pay a deposit rate which is lower than the market clearing rate. To be sure, with all the imperfections in the markets, there is no concrete figure for a market clearing rate. But still, with alternative avenues of saving, like non-bank finance companies "" Reliance Capital is offering 20 per cent at the long end "" and corporate or financial institution bonds (16-16.75 per cent) being increasingly marketed with the retail investor in mind, banks cannot set their deposit rates arbitrarily.

 

Bank deposit rates cannot fall out of alignment with the spectrum of interest rates, or the result could be a debilitating flight of deposits. Banks' costs cannot be reduced simply by cutting back the cost of funds; margins will surely come under pressure. The only way banks can protect themselves is through efficiency gains. Of this, there is no evidence as yet.