Will Loans Turn Cheap?

Now that Mint Road has cut the repo rate by 25 basis points (bps) and cut the daily amount banks have to maintain by way of the cash reserve ratio, will it turn out to be a bonanza for India Inc? On paper it is so. As the moves were preceded by the shift to the new Base Rate (BR) regime based on banks’ marginal cost of funds from April 1.

The repo rate was cut twice last fiscal: by 25 bps in June 2015 and by 50 bps in September. As per the pact signed with North Block, Mint Road will target CPI inflation. Since then the average bank BR has moved lower to 9.3-9.7 per cent (from 10-10.25 per cent) while the interest rate on deposits (1 year and above) to 7-7.90 per cent (8-8.75 per cent). And CPI is ranged at 5-6 per cent levels; WPI is next to nothing.

Every time, RBI cut its key rates, lending rates still held firm. Mint Road grew tired of banks which peddled the view that their cost of funds had not fallen. It led Rajan to quip (6 April 2015) that it was “nonsense to assume that the cost of funds had not fallen”. The BR is the floor rate below which banks cannot lend. It is based on the marginal cost of funds and is expected to be more sensitive to changes in policy rates. A big change right now is Mint Road has made clear its intent to move towards a system where the money markets would be in a “neutral mode” on liquidity — from the earlier “deficit” of one per cent of liabilities. Will it alter the picture?

One of the main reasons why lending rates have held stubborn are non-performing assets (NPAs). At the secular level, stressed assets have risen five-fold since 2011 to $133 billion in 2015, says consultants Alvarez & Marsal (A&M). “During the same period, total advances grew by 1.8 times, pointing to significant asset quality deterioration at Indian banks,” says Nikhil Shah, managing director at A&M. If anything, the NPA situation has worsened though for the right reasons — to clean up balance-sheets for good. But its effect is the same. A cut in the BR — banks will henceforth declare a calendar for its reset every month — will affect banks’ net interest rate margins (NIM).

A few analysts have pointed out that given the lack of growth, banks should cut deposit rates a bit more aggressively as lending rate cuts are unlikely to boost credit demand. Banks cannot afford an aggressive reduction in NIMs at a time of slow growth as it results in more capital consumption; it’s counter-productive. You may still see a lower BR in the days ahead; just how much banks will lend at a margin of BR plus is what matters!