Good news: Whether RBI cuts it or not, lending rate is headed downwards

Whether former International Monetary Fund (IMF) economist Raghuram Rajan will finally listen and act to the desperate cries for a rate cut in the December policy still remains a riddle but a sharp, sustainable decline in credit growth could force banks to cut their lending rates regardless of what the central bank does in its policy.

Bank credit growth, especially that to mid-sized and large firms, hasn’t picked up so far this fiscal year as the positive wave created by the Modi-factor hasn’t yet translated to real investments in the economy, enabling projects to return to track and approach banks for fresh funding.

Loan growth has lagged far behind the deposit growth for long resulting in a dilemma for banks as to how to deploy their excess funds. There is a carry cost for the surplus cash lying with the banks when credit grows slower than deposits.

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In fact, the real reason why many state-run banks have went on a deposit rate cut spree in the recent weeks is to slow down their deposit mobilization. If the demand plunges further, banks will have no option but to start lowering their lending rates sooner or later.

A clutch of banks including public sector State Bank of India, Bank of India, Andhra Bank and private sector ICICI Bank had revised rates in the recent weeks by up to 100 basis points (bps). One bps is one hundredth of a percentage point.

“In such a situation, banks would try to discourage further deposit accretion since they are already flush with liquidity,” said the banker.

Growth in bank lending in the 12 months until September stood at mere6.7 percent on a year-on-year basis compared with 8.7 percent in the year-ago period. The sharpest decline in the credit growth was seen in the fund flow to industries, with most banks shifting focus to safer retail lending.

Loan flow to medium sized companies shrank by 2 percent in the 12 months period from a growth of 4.3 percent in the year-ago period, while loan growth to large companies slowed to 4.7 percent from 18 percent on a year-on-year basis.

Deceleration in credit growth to industry was observed in major sub-sectors, barring construction, glass and glassware, beverages and tobacco and mining and quarrying. So, where has the money gone? The answer lies in loans to individual for consumption purpose.

In the 12-month period, credit flow to retail, such as consumer durables, personal loans and credit card outstanding has significantly picked up.

The reason for poor growth of credit to industries is simple. New projects are yet to come up despite the revival talk. That’s because fresh investments are yet to happen, which would have then required companies seek money from banks.

Analysts said a slew of factors such as slow growth in credit, fall in cost of funds of banks and decline in retail inflation have set the platform ready for reduction in lending rates.

“Interest rates are on a downward path as indicated in the bond market,” said Vaibhav Agrawal, vice-president research at Angel Broking Ltd. “Many banks have already cut the deposit rates and this will follow reduction in base rates,” said Agrawal.

Rates begin to ease

In fact, rates have already begun to trend downwards in the financial system regardless of what RBI has done so far.

In the recent years, the RBI’s rate action hasn’t had much impact on banks’ lending rates and monetary policy transmission has been limited.

Instead, individual banks have acted in line with their own asset-liability situation to revise their interest rate structure.

For instance, in last one year, even though RBI has hiked their lending rates several times to fight inflation, not many banks have hiked their base rates as loan demand has remained muted.

In the backdrop of a decline in retail inflation in recent months, the bond market has already factored in a benign interest rate scenario. The yield on the 10-year benchmark bond has eased to 8.19 percent in November, 2014 from 8.96 percent in the beginning of the fiscal.

The decline is visible in the rates on commercial paper (CP) and certificate of deposits (CD) as well. One-year CP rates have eased to 8.93 percent in November from about 9.55 percent in April, while one-year CD rates have eased to 8.73 percent from 9.15 percent. CPs and CDs are instruments used by corporates and banks to raise short-term funds.

As rating agency Crisil has noted, data suggests that rate cuts have not necessarily led to revival in investments in the past but returns have played crucial role.

The current deposit rate cut spree will most likely be succeeded by reduction in lending rates across segments and even in base rates of banks if the credit growth remains subdued and economic revival takes longer than expected.

On the other hand, even a quarter percentage point repo rate cut may not prod banks to effect significant cut in their lending rates. Banks are likely to take a call based on their individual asset-liability conditions.