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

The Economic Times - - Money & Banking -

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.


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.


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.”

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