For rates to fall, cost of funds needs to come down first, say bankers

Last Updated: Tue, Dec 18, 2012 21:41 hrs

The Reserve Bank of India (RBI) has indicated a coming change in its monetary policy to a more growth-oriented one in the fourth quarter, fuelling expectations of a rate cut cycle from January. However, bankers said the cost of funds needed to come down for the effective lending rate to reduce.

In Tuesday’s mid-quarter review, the central bank refrained from cutting the repo rate, at which it lends to banks. It also left the cash reserve ratio (CRR), the proportion of deposits that banks need to keep with RBI as cash, unchanged at 4.25 per cent. Reduced by 50 basis points (bps) in April, it was kept unchanged in the following five policy meetings due to inflationary pressures.

“We have our asset liability committee meeting on Tuesday and will take a view on the rate cut. Whenever the CRR was cut adequately, we passed on the benefit to our customers through a rate cut. Since there is no CRR cut this time, there is nothing to pass on,” said Pratip Chaudhuri, chairman, State Bank of India (SBI).

According to bankers, though the cost of funds on wholesale deposits has come down by 150 bps over the past nine months, there is very little reduction of retail liabilities. As a result, the impact on overall cost of funds is only 50 bps over the past few months. Following the reduction in CRR by 175 bps since January, banks have reduced their base rate – the reference lending rate to which all loans are linked – by 15-25 bps since April.

In addition, some public sector banks such as SBI and Union Bank of India have reduced their spreads on different loan segments, including housing and automobile loans, which brought down effective interest rates.

Looking ahead
“The movement in lending rates happens with the movements in cost of funds. It’s too early to say what will happen in January. Having said that, starting from the next quarter, interest rates should be on a downward trend. How fast, how sharp, how early, it’s all very difficult to say,” said Chanda Kochhar, managing director, ICICI Bank.

Bankers said the cost of funds will only come down if the tight liquidity conditions ease. While attributing the tightness to slow government spending, RBI Deputy Governor Subir Gokarn said the central bank will infuse liquidity, if needed, by buying bonds via open market operations.

“As of now, the liquidity is tight. Money supply hasn’t grown in line with what RBI has said. If there is substantial liquidity, it should mean something like LAF (Liquidity Adjustment Facility) borrowing (daily) of Rs 20,000-30,000 crore. Then, the cost of funds could change. There is a very clear mechanism that if the cost of funds change, we change the base rate. We are very conscious about the consumer responsibility,” said Aditya Puri, managing director, HDFC Bank.

Banks’ lack of interest in reducing the deposit rate is also due to the slow pace of deposit mobilisation, the growth of which was lower than credit growth. In the current financial year, while credit expanded about 17 per cent on a year-on-year basis till November 30, deposit growth was 12.8 per cent during the period.

According to Debabrata Sarkar, chairman and managing director, Union Bank of India, apart from high inflation, alternative investment options such as gold and real estate have contributed to the slower pace of deposit accretion.

Going ahead, bankers hope RBI will start cut lending rates from January as inflation exhibits a declining trend. “In the first quarter of 2013, inflation will start to head down and RBI would be more accommodative on the policy rate cut. What RBI has done on Tuesday was within the expectations of the Street,” said Gunit Chadha, Co-CEO, Asia Pacific, Deutsche Bank.

Wholesale Price Index inflation fell to 7.2 per cent in November, mainly owing to softening of prices of vegetables, minerals and fuel, though those of cereals and protein-based items such as eggs, fish and meat firmed up further, the central bank said.

“Significantly, core (non-food manufactured products) inflation eased, aided by a decline in prices of metals, cement and chemicals. The seasonally adjusted three-month moving average annualised momentum indicator also points to ebbing of inflationary pressure,” RBI said. Lower inflation, it said, would provide space for a growth-focused policy stance.

More from Sify: