IS RBI CHASING A MIRAGE?
The regulator is right in whipping the banks’ cartel to pass on benefits of lower fund cost to customers.But banks have problems of differential costs, andNPAs weighing them down where lending formulas may be ineffective. Meddling beyond a point may disto
Two days after State Bank of India chairman Arundhati Bhattacharya slashed savings bank deposit rates in an unprecedented fashion, Kotak Mahindra Bank executive vice chairman Uday Kotak tweeted, ‘borrowers matter, so do savers,’ and declared that his bank was in no hurry to lower rates. The action and reaction of the two top bankers reflect the paradox of the Indian banking industry.
Between the two events, the Reserve Bank of India said banks’ conduct in passing on the benefits of lower interest rate through the so-called Marginal Cost of Funds based Lending Rate, or MCLR, has not been ‘entirely satisfactory’ and announced the constitution of a study group to ensure the concept works.
While banks are fighting their own battle in the marketplace for remaining profitable and gaining market share depending on where they stand, the regulator’s focus on banks passing on benefits of lower interest rates raises the question of free market principles and, at the same time, its role in preventing consumers from being fleeced.
Indian banking is vertically divided into the loss-making state-owned banks and a bunch of highly profitable private sector ones looking to gain market share at the cost of the leaders who have benefited from state support.
Here the important questions arise—when market forces are at play, is it right for the regulator to meddle in the way banks set interest rates? Is it the job of the regulator to prescribe formulas when the dynamics that each bank faces are different from that of the other?
“World over, it is the competition that determines the rates and not the regulator,” says the head of a state-run bank who did not want to be identified. “And if the regulator wants market-determined rates, they should not decide the formula. Instead, they should leave it to the market forces. In no other country the central bank micro-manages lending rates.”
The banking industry and the central bank have been at loggerheads for years on either passing on the benefits of lower interest rates, or raising rates to reflect the RBI’s tightening monetary stance where it increases the repo rate, the rate at which it lends to banks, to rein in inflation.
In the past three years, the central bank has reduced the policy rate by 200 basis points, but the weighted average lending rates have fallen by 145 basis points. A basis point is 0.01 percentage point. Bankers say though it may appear to be out of sync with the policy, the MCLR regime has been better, though helped by a gush of liquidity due to demonetisation.
“If you take the starting point from the period when rate cuts started taking place, you may think that MCLR cuts have not been fully in line with bank lending rate cuts,” says Dipak Gupta, joint managing director at Kotak Mahindra Bank. “But if you start from a period of six months or nine months earlier than that when policy rates were actually moving up and MCLR did not move up correspondingly, you will realise that MCLR cuts have been pretty much in line with the policy rate.”
To ensure that its policies reflect the market position, RBI has over the years come up with many instruments to remain effective, but all of which have failed either due to impracticality, or banks found ways to circumvent them. Some of them are the Prime Lending Rate, the Base Rate and now the MCLR.
While the broad market principles may leave no room for regulatory micromanagement, the players have not been completely fair to customers in their business. CHARAN SINGH |
The state ownership of banks has led to rates being uniform across three-fourths of the system. The lending and deposit rates of most state-run banks are similar, and if there are differences, they are insignificant.
“The problem is there is no competition among banks for lending rates to be marketdetermined,” says KC Chakrabarty, a retired RBI deputy governor. “All the PSU banks are government-owned, so they have to be seen as one entity.”
At least four state-run banks have one-year term deposit rates of 6.50%, and another four banks have MCLR of 8.40%.
Before the mid-90s, the central bank was determining everything—from the loans target to lending rates to deposit rates. But that slowly gave way to independence on many counts, including the savings bank rate in October 2011. Although the regulator maybe confounded by the sticky lending rates of banks, when competitive spirit caught the industry the RBI raised its voice, crippling market forces early. When the then State Bank of India Chairman OP Bhatt took the fight to market by offering lowest interest rates on mortgages, rivals painted it as ‘teaser rate’ and unfair. No time was lost before the regulator turned vocal to condemn it. “The regulator has to lay down the ground rules for the banks, and leave it to the banks to frame the lending rates,” says former SBI chairman Pratip Chaudhuri.
Furthermore, RBI’s stance on liquidity at deficit held banks from passing on the benefits. Banks’ cost of funds is not determined by RBI’s policy rate, but the price they pay for funds raised by them.
PROFITEERING OR INEFFICIENCY
One factor that is justifying the regulatory micro-management is the high net interest margin (NIM), a measure of profitability, of Indian banks compared with their global peers. SBI’s NIM is at 2.8% and HDFC Bank has it at 4.3%. Let’s compare these with JPMorgan’s 2.7% and Chinese multinational ICBC’s 2.12%. But the comparison may be misplaced as the factors driving the business are completely different. “You cannot compare NIMs across countries as you need to factor in the nature of the product, the nature of risk in the market, etc,” says TT Ram Mohan, professor of Finance at the Indian Institute of Management at Ahmedabad. “For instance, micro-finance yields are inherently high, but then the cost of operations is also extremely high because these are small-ticket loans.” Regulatory meddling and prescription of formula for lending rates are also punishing efficient banks. If a bank has built up a high current and savings bank account, or CASA, where interest rates are low, it cannot enjoy the benefits, but has to pass on.
“MCLR penalises efficiency. If as a bank I have a higher CASA ratio and, hence, lower cost of funds, I have to offer lower rates in the marketplace,” says Kotak’s Gupta. “Another bank with a poorer CASA ratio and higher cost of funds gets to price higher for the same asset. This is not appropriate. As a stronger bank, I have worked hard to obtain a better CASA ratio. But I don’t get to gain from my efficiency, I have to pass it on. There are some conceptual issues on MCLR,” he adds.
SHOW THE CARDS
It is no secret that an average bank customer is a disappointed one, be it service, charges, or just the demands. The origin of the regulator stepping in was that banks were forcing small borrowers to subsidise the big ones. Indian banks had given an exclusive definition for subprime lending – the big triple-A borrowers were loaned funds below the socalled “prime lending rate’, which was officially the best rate. In a way, retail and others are subsiding big firms. While credit rating determined rates for big corporations, retail borrowers rarely got such a privilege.
“While there is a base rate, over that there is a premium which depends upon the risk of the borrower, tenure of the loan, and cost of operations,” says Ram Mohan of IIM Ahmedabad. “Banks can easily lower the rating of the borrower and charge a higher premium, so finally the lending rate doesn’t change.”
Regulatory intervention may appear to be meddling and micro-managing in a corporation’s affairs but, in a way, banks themselves invited this due to their behaviour. “Nowhere in the world does the central bank determine the formula for lending rates,” says Chakrabarty. “The regulator says that the lending rates should be transparent, nondiscretionary and marketdetermined. All these three factors are missing and, therefore, RBI has to intervene to protect customers.”