Costly deposits stymie banks' rate cut efforts

Interest rate reductions by State Bank of India (SBI) and ICICI Bank notwithstanding, other banks feel a cut in lending rates would not be possible without peak deposit rates falling closer to 8 per cent from 9 per cent now.

Interestingly, banks are borrowing one-year bulk funds through certificates of deposit at around 8.25 per cent against 9-9.50 per cent for retail deposits of a year and above.

A senior official with a public sector bank said the two biggest banks, particularly SBI, needed to lower their peak deposit rates sharply to enable smoothening of the deposit rate curve.

The difference in interest rates on deposits of over 300 days to less than a year and for a year and above was unusually high at 175-275 basis points.

SBI last week reduced retail lending rates by 50-200 basis points and peak deposit rate by 25 basis points to 9 per cent, while ICICI Bank cut retail loan rates by 25-50 basis points and interest rate on special deposit schemes by 50 basis points to 9 per cent.

"Given the current conditions, 9 per cent is still a high rate for a year, when certificate of deposits (bulk deposits) are being mopped up at 75 basis points lower (8.25 per cent)", a senior treasury official with Canara Bank said.

Rupe Rege, chief economist at Bank of Baroda, said, "Each bank would determine interest rates based on circumstances specific to it. Each bank also wanted to maintain financial muscle with the busy season round the corner."

The high liquidity in the banking system is also because the Reserve Bank of India's (RBI) purchased foreign currencies to prevent a sharper rupee appreciation. Bankers also felt that liquidity would get volatile and want to be meet credit as demand rises. The rupee has appreciated by over 12 per cent in 2007 so far.

A senior SBI official said, "Banks, including ours, wanted to play safe. In the fourth quarter of last year, the banking system had a bad experience of having to pay huge interest rate on bulk deposits (as high as 11-13 per cent) for getting resources to meet credit commitments. So there is a motivation to keep rates high. This brings in certain rigidity for bringing down deposit rates."

Crisil's head financial sector rating Tarun Bhatia said, "Banks want to be ready for an uptick in credit demand in the second half. The deposit rates will continue to remain around 9 per cent."

A senior Punjab National Bank official said bulk deposit rates and CPs rates had dipped. Around end of financial year 2006-07, the bulk rates as high as 11.5 per cent. Now they are below nine per cent.

"Now, we are in a situation where rates for bulk deposits are lower than those offered for certain retail deposits. Nowhere in the world, such a situation exists," the PNB official said.