End of road for low-cost loans; beginning for lower inflation

Indians' romance with cheap loans finally ended in 2006, with the Reserve Bank of India (RBI) industriously designing ways to make banks balance their lending and deposit portfolio.

The final salvo to check spiralling credit growth as also inflation that has been hovering dangerously close to the threshold level of 5.5 per cent came in December, when the apex bank hiked cash reserve ratio (CRR) by 0.50 per cent to 5.5 per cent sucking out Rs 13,500 crore of excess liquidity.

However, the CRR hike, termed by RBI Governor Y V Reddy as a "blunt tool" and used after a gap of about two years surprised the industry, which now expects a fresh round of interest rate hikes "� for both lending and deposits "� in the new year.

The RBI in 2006 raised the short-term lending rate by one per cent while the reverse repo rate, through which it absorbs surplus cash in the banking system, has been raised by 0.75 per cent.

During the October Mid-Term review, it raised the repo rate by 0.25 per cent and increased the corridor between repo and reverse repo to 1.25 per cent. However, in the absence of desired results, the apex bank resorted to the blunt arrow in its quiver to hit the bull's eye and the results followed.

"It is not a liquidity squeeze but a signaling effect that have taken the interest rate up," said K V Kamath, managing director, ICICI Bank, which was the first to respond to the CRR hikes by raising both lending and deposit rates.

Kamath maintained that the Rs 13,500 crore outgo due to the CRR hike was not very significant for the banking industry.

The country's largest lender State Bank of India and Bank of Baroda raised their benchmark prime lending rate (PLR) as a result of RBI tweaking CRR. Besides, private sector Centurion Bank of Punjab too raised lending rates.

"Our profit margins are under pressure," admitted SBI Managing Director Yogesh Agarwal.

All these banks have also increased their deposit rates for fund accretion, another major challenge for the banking industry in the coming days.

To make deposits attractive, several banks launched value-added current account and long term fixed deposits with interest rates as high as 8.5 per cent per annum.

The process of hiking sub-PLRs by public sector banks to bring them more in alignment with their benchmark PLR could gather greater momentum in the new year, making credit dearer for corporates.

"There is no doubt that there is a growth momentum in the economy," Rana Kapoor, managing director & CEO, Yes Bank, said.

The challenge before the system is to channelise this into productive sectors and all of the RBI's moves are designed toward this end, he said on the CRR hike.

Governor Reddy has shown a penchant for surprises and has hiked rates when least expected and left them untouched when expected. Secondly, both the US Federal Reserve and the Bank of Japan (BoJ) have not tinkered with their rates in the recent past.

Besides, oil prices softened toward the end of 2006 which could have a further tempering effect on rates, though, now inflation is primarily suspected to be fuelled by an increase in prices of primary products.

With the government reducing petrol and diesel prices, inflation "will be impacted," said RBI Deputy Governor Rakesh Mohan and this could be another factor that might influence the apex bank to hold back a rate hike.

The CRR hike will in all probability force banks to reprice their lending rates, though whether there will be another round of PLR hikes is debatable.

Unlike their private sector peers, tinkering with lending rates, especially home loans and advances to productive sectors, has not been an easy decision for public sector lenders.

The last time when banks went on an interest rate hiking spree in August, the government, being a majority shareholder in public sector banks, fired a missive asking them to get the nod of their board of directors for the PLR hikes.

This made all public sector banking majors like SBI and PNB among others to get the hikes ratified by their respective boards. Reports about Mint Road at loggerheads with the finance ministry were rife but soon fizzled out.

"The hikes if any in deposits or lending rate would be there as banks would try to maintain their margins," says Indian Banks' Association Chief Executive H N Sinor.

Looking back, he feels that banks in 2006, especially public sector banks greatly improved their efficiency by cleaning their balance sheets, adopting technology and becoming more and more customer centric. "If 2006 was the watershed year, 2007 would be better," he feels.

Banks' appetite for acquisitions is anything but small going by three major acquisitions in the final months of 2006, with the highlight being IDBI's acquisition of the under- moratorium United Western Bank for which more than a dozen banks, including foreign majors, emerged as suitors.

While Bank of India became the third Indian bank to acquire an overseas bank, when it acquired a controlling stake in PT Swadesi, an Indonesian bank, ICICI Bank has bid for The Sangli Bank, while CBoP acquired the Lord Krishna Bank to make inroads in the rural areas, the next hot market for the private sector and foreign banks.

However, despite the government's talk on consolidation the public sector major have yet to show some movement.

But the intent was evident when three mid-sized public sector banks, Oriental Bank of Commerce, Indian Bank and Corporation Bank joined hands in a one-of-its-kind alliance to take on challenges of scale.

The three banks, without an acquisition or merger, have entered into a pact to leverage on their combined expertise to achieve desired scale.

Despite all the learning, the industry has a long distance to go in the shortest possible time. A study by leading research firm KPMG found that majority of banks in the country are yet to set up specific budgets for Basel II norms.

KPMG said approximately 75 per cent of the banks surveyed have not specifically budgeted funds for their Basel II programme, which requires banks to make funding provisions for managing various risks.

To give banks more time to prepare for Basel II, RBI has extended its deadline for implementation by another two years.

Apart from taking preemptive steps and making interventions as needed, the apex bank also kept the lending to real estate under its watchful eye. From stressing on quality of credit to increasing provisioning requirements for big ticket lending in real estate, it tried to counsel banks to avoid any signs of overheating in the economy.

It also brought bank's exposure to Special Economic Zone (SEZs), defined as the engine of growth by Union Government, as an exposure to real estate and imposed the same high provisioning.

Though the commerce ministry had made its submission to the Reserve Bank in this regard, the apex bank has not yet reviewed its earlier stand.

It was also an year when Indian public sector banks like Union Bank, Bank of India, Federal Bank, IDBI among others diversified their services by entering into the insurance business. Some other public sectors too are looking closely at entering the sector in near future.

As curtains come down on 2006, the legislation to help State Bank of India (SBI), the largest bank of the country, to raise funds from the market and lower the Reserve Bank's holding to 51 per cent has been introduced in Parliament.

RBI owns 59.73 per cent stake of SBI, which it wishes to lower to 51 per cent by necessary amendment in the SBI Act.

The bill seeks to allow SBI to raise funds through preference shares or private placements. It will also be allowed to issue bonus shares, which it could not do under the existing Act.