Prospects of floating lending rate, fixed deposits spook bankers

If the private sector banks don't play ball, there is very little public sector banks can do to make the product a success

The Reserve Bank of India’s (RBI’s) plan to formalise repo rate as the external benchmark for lending is possible only when deposit rates are also linked to the same benchmark and all banks together move at least a part of their deposit portfolio to floating rates, say bankers and analysts.
 
If the private sector banks don’t play ball, there is very little public sector banks (PSBs) can do to make the product a success. A workable solution is that the lending can be done to the extent the bank has managed to garner floating rate deposits. Otherwise, there could be deep asset-liability mismatches in banks’ books.
 
This can still be done for retail loans, which are anyway at the rock bottom of the rate spectrum. But for other loans, a repo-linked lending rate could be quite harmful for Indian banks.
 
If the deposits and lending rates are linked to a floating benchmark, banks would face problems in both rising and falling interest rate scenarios.
 
In a rising interest rate scenario, customers will find their equated monthly installments (EMI) rising, which may not be commensurate with their rise in income. This may lead to defaults, which would be a big issue for big-ticket corporate loans.
 
In a falling interest rate scenario, customers are likely to withdraw their deposits in search of a higher return in some other bank. The RBI itself has allowed premature withdrawal of deposits without any charges.
 
“Hence, all banks will have to come together, which is possible when the RBI clearly tells banks to do so. But that would be overstepping the RBI’s role as regulator, and forcing the banks to accept a benchmark, which is set by the RBI and not the market,” said a senior banking sector expert.
 
But private sector banks are unlikely to migrate to such a system voluntarily.
 
“It’s not necessary to use only external benchmarks, there are multiple avenues to meet the requirement that the RBI wants us to do... What the RBI is essentially looking at is that the rates are being cut and there should be better transmission,” said Rajiv Anand, executive director for corporate lending at Axis Bank Ltd on Monday.
 
Speaking on the sidelines of FIBAC, and reacting to the governor’s call for formalising repo-linked loans, Anand warned that repo would be more volatile than marginal cost-based lending rate (MCLR), which is set every quarter.
 
“Generally, we’ve seen that retail customers, when the rates are falling, they want to see faster transmission but remember that faster transmission will happen on the way up as well,” he said.
 
SBI Chairman Rajnish Kumar has already said that while repo linking is workable, it should not be only on the side of lending rates.
 
“We can’t reduce rates so much that we become uncompetitive,” Kumar has said at FIBAC on Monday. Other bankers also agree with Kumar and Anand’s assessments.
 
“The issue here is that repo is a signaling rate, and something that banks use to borrow only 1 per cent of their NDTL (net demand and time liabilities). Now, 1 per cent cannot be setting rules for the 99 per cent of the deposits. That is absurd,” said the person, requesting anonymity.
 
According to bankers, a deposit rate is set after considering competition, market rates, small savings rates and liquidity. If banks’ deposit rates fall much faster than the small savings rate, or if the competition doesn’t lower deposit rates, the deposits can easily move out.
 
On the other side, the bank cannot just link their lending rates to repo, while keeping the deposit rates fixed for a particular term. This is because lending rates get repriced immediately, whereas deposit rates run a contract for a fixed period. Hence, profitability of banks could take a serious hit.  “The best option we believe could be that the regulator enforces all incremental bulk deposits, henceforth to be repo linked/flexible,” wrote State Bank of India (SBI) Chief Economic Advisor Soumyakanti Ghosh.
 
“Needless to say, most of the bulk deposits (Rs 2 crore and above) are from institutions. It is thus logical that large institutions could afford to take an interest rate risk as this would spare the retail depositors from taking the same,” Ghosh wrote.
 
Bankers say Indian banks earn very less fee income to make good of any hit to the net interest income (NII) and ultimately the net interest margin (NIM), a key profitability indicator. Increasingly, the RBI has brought down processing charges to near zero. There is no charge on funds transfer as well.  “Most public sector banks have NIM of less than 2.5 per cent, which may seem a little higher than global range of 1.5-2 per cent, but the fee income of global banks in return on assets (RoA) range from 1.2-1.8 per cent, whereas for Indian banks, it is only 0.3-0.4 per cent,” said an analyst.
 
Now when provisioning is added, the Indian banks are already staring at a deep loss, which will force them to continuously depend on the government for capital needs.
 
“Our fee income makes good for only 20 per cent of our operating expenses. We cannot compromise on our profitability, and hence, lending can be benchmarked to repo only when deposits are also on the same benchmark,” said a banker.  Bankers also said in developed markets, lending and deposits are both linked to external benchmark such as LIBOR and LIBID, but the deposits are only for a few months, whereas in India, depositors keep money for more than three years and even for 10 years.
 
“It is not that floating rate deposits were not introduced, but nobody took it. Even the corporates don’t want to invest in such deposits,” said the banker.  “Instead of boosting saving, the measures will scare depositors away,” said the analyst.