MAVERICK VIEW. There’s more to banking than repo rate

Governor Raghuram G Rajan held the repo rate unchanged at the December 1 review. It is a relief not to hear noises of dissonance from government honchos. But there is life beyond the repo rate.

In the course of the policy statement, as also the press conference and the dialogue with analysts, various issues have come up which need further deliberation.

The policy statement stresses that since the rate reduction cycle that commenced in January 2015, less than one half of the cumulative policy repo rate reduction of 125 basis points has been transmitted by banks (the median base lending rate has come down only by 60 basis points). The Reserve Bank of India is on the verge of finalising the methodology for determining the base rate based on the marginal cost of funds. In the days of yore (1990s) the RBI did not hesitate to explicitly tell the banks as to what should be the reduction or increase in lending rates. But we have come a long way since and the RBI would do well not to use strong suasion to get interest rates down.

For the banking system, current and savings bank deposits (CASA) account for a third of the total while term deposits account for about two-thirds. On the assumption that the term deposits are approximately divided equally between one-year, two-year and three-year deposits, the transmission to lower lending rates would take time. Forcing banks to go over to a marginal cost of funding to determine the base lending rate could force banks to undertake swingeing reductions in term deposit rates which would hurt financial savings.

Again, tilting the scales in favour of fresh borrowers rather than existing borrowers would not be prudent. The State Bank of India chairman, Arundhati Bhattacharya, and other bank honchos have drawn attention to the adverse effect of moving over to marginal cost of funds for determining the base lending rate. The RBI should take this into account and tweak its stand on this. The RBI would do well to remember the time-tested central banking rule of up by ones and down by halves.

The endeavour to clean up banks’ balance sheets by March 2017 is commendable but non-performing assets (NPAs) are hardy creatures and, notwithstanding all attempts to curb them, they grow like Hydra. Further, although the restructured assets are meant to be of a different genre, they inevitably deteriorate into NPAs. The problem is in the incipient stage and NPAs should be extirpated from the system at that stage. There has to be a certain element of ruthlessness in dealing with NPAs and the basis for dealing with NPAs has to be to ‘never forgive and never forget’.

It is invariably during the upswing of growth that the seeds of NPAs are sown. Borrowers who cannot handle payment of dues during the low point of the interest rate cycle would never be able to adhere to payments when interest rates rise. It is here that there are dangers in going too fast and too far in undertaking interest rate reductions.

The various small savings schemes of the government, at present, range between 8.7 and 9.3 per cent while banks are offering 7.5 to 8.0 per cent on term deposits. The Centre should think hard before reducing small savings rates.

First, they have a social objective of providing protection to the weaker segments of society. Secondly, government small savings rates do not move around as easily as deposit rates of banks. Thirdly, in the case of the provident funds (PFs), they are the only social security available for the disadvantaged and these are long-term funds. Slashing PF rates is also not desirable as this will result in inter-ministerial disputes. Hence, in any reduction in small savings rates, the government would do well not to reduce the interest rate on PFs.

The savings bank deposit rate has been an enervating issue ever since the rate was deregulated by the RBI in October 2011.Other than a few small banks that have raised their rate, and also lowered it as the overall interest rate structure went down, the bulk of banks — public, private and foreign — have stuck rocklike to the 4 per cent savings bank rate, which was the last regulated rate, irrespective of changes in the cost of funds and the return on funds. One would have expected that with CASA varying from bank to bank, each bank would see its advantage in increasing or decreasing its savings bank rate. The ground realities are very different — all banks maintain the rate at 4 per cent.

This issue came up at the governor’s press conference. While responding, the governor raised a theoretical point that a single rate could also reflect “perfect competition”. Unfortunately in these days of so-called transparency, one cannot invoke Disraeli’s dictum of “never explain”! The harsh reality is that the Big Boys in the banking system are running an informal cartel.

There is a glimmer of hope that the RBI may, at long last, look into this issue. The Competition Commission of India had, about a year ago, said that it was looking into the matter. The CCI has imposed exemplary fines on insurance companies and some other industries. One dreads to think how high the penalties on banks would be if the CCI rules that this is a case of cartelisation. Taking a leaf out of the action by RBI in 1989 to nip the cartelisation when the general lending rate was freed, an unequivocal rap by the RBI would shatter the four-year-old savings bank cartel.

The writer is a Mumbai-based economist