Falling market share, not Rajan or Jaitley, will force banks to cut lending rates

Mumbai: After the 2 June monetary policy announcement, several banks have announced a reduction in their base rates, or minimum lending rates, by up to 25 basis points, thus making the average base rate in the banking industry now around 10 percent. While some of the larger banks, like State Bank of India and ICICI Bank, have managed to bring down their lending rates to 9.7-9.75 percent, smaller lenders have adjusted their rates at 10 percent or marginally above.

 Falling market share, not Rajan or Jaitley, will force banks to cut lending rates

Bombay Stock Exchange. Reuters

The point to be noted here is that banks have been extremely reluctant in lowering their lending rates despite a 75 basis points (bps) cumulative cut in repo rate by the Reserve Bank of India (RBI) so far this year. Most of the banks didn’t cut their lending rates in the last two occasions when RBI cut repo rate.

Even with the latest round of cuts, most banks have merely adjusted their high lending rates to the market rates. In short, there is no proportional reduction in bank lending rates if one looks at the RBI rate cuts. This, probably, prompted Finance Minister Arun Jaitley to ask banks to cut rates further in his recent meeting with bankers, to which banks have responded in positive.

Banks have been turning a deaf ear to rate cut calls due to a few factors, mainly stress on their balance sheets. There has been a spike in bad loans in the recent years, which has beginning to hurt in the form of high provision requirements. Interest earnings too have come under pressure and the risk of fresh loans turning sticky persists given the delayed economic recovery. In the case of state-run banks, capital shortage is a serious concern. A lending rate cut would hurt their earnings further.

Nevertheless, banks will be pushed to the corner eventually to cut rates-not because of Jaitley or, for that matter, due to the persuasion from RBI governor, Raghuram Rajan—but because of the market dynamics. The fact is that banks are losing out share of corporate credit and even some part of the retail loans to competition.

Many corporations, especially those with good credit ratings, increasingly prefer corporate bond market to raise funds over bank loans on account of lucrative interest rates. A company can raise funds at 7.5 percent to 8 percent by issuing commercial papers, whereas the minimum rate at which they can get a bank loan is 10 per cent in the banking system. And, remember, they rarely get loans at the base rate. The final rate comes with a premium over the base.

Indian companies raised a whopping Rs1,14,460 crore in the 12 months ending April 2015 by way of issuance of commercial papers as compared with Rs3,450 crore in the corresponding period in previous year, enthused by the falling rate of interest. One year CP rate is presently at 8.65 per cent compared with 9.66 per cent in last April.

According to the data with the market regulator, Sebi, in fiscal year 2015, companies raised Rs 4.04 lakh crore through 2611 corporate bond issuances, as against Rs 2.76 lakh crore raised in fiscal 2014 from 1924 issuances.

Besides the demand slowdown associated with a sluggish economy, one of the major reasons why banks have seen a sharp fall in their lending growth is the gradual shift of large corporations to the corporate debt market. The smaller ones are still knocking the doors of banks, but banks are typically less inclined to lend to them aggressively on account of high risk perception on these firms.

Credit to industry increased by a mere 6.4 percent in April 2015 as compared with the increase of 12.3 percent in April 2014. The slowdown in credit off take was observed in all major sub-sectors, according to the data release by the central bank. The story is not so different on the retail loan market also. Many fresh home, auto buyers are moving towards the non-banking finance companies due to competitive rates and faster processing, resulting in tight competition for banks.

On a year-on-year basis, banks home loan portfolio has grown at 17.4 percent as on till April, 2015 as compared with 18.4 percent in the previous year. Even personal loans have dropped to 13.3 percent from 15.1 percent on year. Banks’ overall loan growth has fallen to 8.7 percent from 13.9 percent in the year-ago period. Banks cannot afford to keep losing their share in this fashion. They will have to resort to lowering their lending rates to attract borrowers.

As Firstpost noted before if one purely looks at the interest margins, there is indeed room to cut their lending rates since Indian banks have the highest Net Interest Margins (NIMs) in the comparable markets.

If banks were willing to settle for lower NIMs, fall in lending rates would have been much sharper. At present, at least nine banks among the big-sized lenders have NIMs above 3 percent and there are three others above 2.5 percent. Kotak Mahindra Bank has the highest NIM at 4.87 percent. SBI and ICICI Bank have their NIMs at 3.16 percent and 3.57 percent, respectively.

In comparison, the average NIMs of US banks stand around 2.95 percent. The average NIMs of Indian banks had fallen from 3 percent in 1999-2000 to 2.5 percent in 2009-10 but the bigger banks grew their NIMs aggressively thereafter.

In short, further reduction in lending rates will happen sooner or later. If banks are unwilling to initiate the process on their own, the market dynamics will force them to do that.

Editor's Note: The story has been republished with additional details.

Updated Date: Jun 15, 2015 14:14:59 IST