The high cost of funds could come in the way of effective monetary policy transmission, as bankers may find it difficult to cut lending rates aggressively in case the Reserve Bank of India (RBI) keeps banks’ Cash Reserve Ratio (CRR) unchanged at tomorrow’s review. The central bank is widely expected to cut policy rates by at least 25 basis points.
Bankers said lower deposit growth amid tight liquidity conditions have kept them from reducing interest rates on deposits, thereby keeping cost of funds elevated even as the demand for credit is yet to kick off in a big way. In its Annual Monetary and Credit Policy, the central bank had projected growth of 16 per cent in deposits to support economic growth of 7.3 per cent in the current financial year. From the latest data, bank deposits have been growing at 13-14 per cent so far, as compared to 17-18 per cent last year.
“You cannot have this mismatch endlessly. Deposit growth is not happening, even as deposit rates are near historic high levels. If you cannot bring down deposit rates, you cannot cut lending rates,” said the head of global markets at a foreign bank.
For the first time in three years, RBI had reduced its policy rate by more than the expected quantum of 50 bps on April 17. However, none of the lenders have responded with a cut of more than 10 bps in lending rates. More, most banks, including the large ones, are yet to tweak their respective base rates accordingly. This is despite a reduction of 125 bps in the CRR since January 2012.
Lenders have, however, cut the spreads over the base rate to boost credit growth in certain segments. “This does not signify passing the benefit of reduction in cost of funds. It means banks have taken the cut on their margins instead," said a senior treasury official with a public sector bank.
The country’s largest lender, State Bank of India (SBI),which recently cut spreads for small and medium enterprises, agriculture and corporate loans, is yet to see its cost of funds coming off. “Cost of funds is just about stable; may be there is five to 10 bps increase," said SBI chairman Pratip Chaudhuri. Banks are presently borrowing three-month funds at above nine per cent via Certificates of Deposit, reflecting the need for funds, he added.
Currently, RBI is injecting around Rs 80,000 crore daily through the Liquidity Adjustment Facility. Also, the central bank has injected about Rs 70,000 crore via bond purchases under Open Market Operations (OMOs) so far in the current financial year. “In an easing cycle, policy rate cuts can be futile if liquidity conditions worsen, as a higher spread between the repo rate and overnight rate offsets the fall in the policy rates,” said Sonal Varma , economist at Normura.
However, economists expect RBI might continue to address liquidity concerns with the help of OMOs instead of reducing the CRR. Also, deposit growth might not be of concern for banks if credit growth stays low.
“RBI may not opt for reduction in CRR as of now, because it could always inject liquidity via OMOs in the coming weeks. Deposit growth will undoubtedly be influenced by the level of real interest rates, as well as the rate of creation of base money. If there is pick-up in credit, banks could always tweak deposit rates accordingly," said Sajjid Chinoy, India Economist at JPMorgan.
Varma said it was important for the central bank to manage liquidity pro-actively this year because the credit-deposit ratio is at 77 per cent and additional demand cannot be supported unless liquidity is created. So far in the current financial year, RBI has already injected about Rs 70,000 crore via OMOs.
