Scope for further cuts in lending, deposit rates: RBI

Scope for further cuts in lending, deposit rates: RBI

Structural factors, large Govt borrowing, risk aversion may constrain banks.

Interest rate response to monetary policy easing has been faster in the money and bond markets as compared to the credit market.
Our Bureau Mumbai, Jan. 28 Even as the Reserve Bank of India wants banks to respond to its earlier policy cues by cutting deposit and lending rates, its third quarter review of Monetary Policy 2008-09 clearly recognises structural factors, including the administered interest rate structure on small savings, persistence of large government borrowing and risk aversion, that would constrain banks from doing so.Pointing out that the interest rate response to monetary policy easing has been faster in the money and bond markets as compared to the credit market, the RBI said the administered interest rate structure on small savings could potentially constrain the reduction in deposit rates below some threshold. Given that a substantial portion of bank deposits are mobilised at fixed interest rates with an asymmetric contractual relationship, during upturn of the interest rate cycle, depositors have the flexibility to prematurely terminate the existing deposits and re-deposit the funds at higher interest rates. However, in the downturn of the interest rate cycle, banks have to necessarily carry these deposits at higher rates of interest till their maturity.RBI underscored the fact that competition among banks for wholesale deposits, for meeting the higher credit demand in the upswing, leads to an increase in the cost of funds. Further, linkage of concessional lending rates (loans to priority sector) to banks’ BPLRs makes overall lending rates less flexible.Persistence of large market borrowing programme of the Government, the central bank pointed out, hardens interest rate expectations. “The Government’s additional borrowing programme could be managed through issuance of securities by the Government directly to RBI on private placement basis at a negotiated rate. This move will not distort the market yields. This way the cost of government’s borrowing will come down and bond yields in the market will trend lower. But then the FRBM Act and the MoU that the Government signs with the RBI will need to be looked at,” said Mr N.S. Venkatesh, MD & CEO, IDBI Gilts Ltd.With increase in risk aversion, the RBI pointed out that lending rates tend to be high even during a period with falling credit demand.Economic perspective “From the real economy perspective, however, for monetary policy to have demand inducing effects, lending rates will have to come down. As such, current deposit and lending rates have significant room for further reduction,” the central bank said.Major public sector banks, according to RBI, have reduced their term deposit rates in the range of 50-150 basis points. Benchmark prime lending rates (BPLRs) of major public sector banks have come down by 150-175 basis points. Major private sector banks have reduced their BPLRs by 50 basis points, while major foreign banks are yet to do so. The RBI emphasised that as a result of several measures initiated by it since mid-September 2008, banks’ cost of funds would come down. This should encourage banks to reduce their lending rates in the coming months.