Indian banks are hesitant to cut lending rates immediately, citing muted credit growth and stiff competition for deposits, even after the Reserve Bank of India (RBI) on Tuesday made more funds available to lenders.
The RBI has refrained from reducing rates for two months in a row, but has taken steps to increase the availability of funds with banks to boost credit growth.
Tuesday's unexpected decision to reduce banks' minimum mandated government bond holdings, or the statutory liquidity ratio (SLR), would free up funds locked in gilts investments.
In June, the RBI had increased the extent to which banks could borrow from the central bank for financing exports, thereby infusing over 300 billion rupees.
However, muted credit demand due to a sagging economy, which grew at its weakest pace in nine years in the March quarter, could keep banks from cutting rates soon.
"I don't think the SLR cut will achieve the goal of improving credit growth unless credit demand picks up," said Kumar Rachapudi, fixed income strategist at Barclays Capital in Singapore.
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Apprehensive of losing deposits, banks are reluctant to cut deposit rates despite an improvement in systemic liquidity.
"Inflation is high and if you give a rate of interest that is not attractive to the depositor it is quite obvious he will look at other avenues," said K.R. Kamath, chairman and managing director of state-run Punjab National Bank .
"If I can't reduce deposit rates, I'll have to hold on to my lending rates as well."
Most banks have either maintained or reduced their base lending rates only marginally despite a steeper-than-expected 50 basis point repo rate cut in April.
State Bank of India Chairman Pratip Chaudhuri said there was less room for reducing deposit rates because of stiff competition from banks and other savings instruments.
While the SLR cut will potentially increase lendable resources with banks by 600 billion rupees, bankers say they will prefer to stay invested in gilts on concern about deteriorating asset quality.
"Although statistics indicate credit growth is OK, the fact is very few new projects are coming up. So going ahead, credit growth is likely to be lower than what it was two to three years back," said Arun Kaul, chairman and managing director of UCO Bank .
"It is true that in uncertain times banks will go slow on acquiring risky assets," he said. The RBI projects credit growth at 17 percent in 2012/13, and deposits at 16 percent.
Bank loans grew 17 percent in the previous fiscal year that ended in March, while deposits rose 13.4 percent.
However, banks will have to bring down interest rates soon as improved liquidity and muted credit growth will limit the opportunity to deploy funds, Kaul said.