BANKING MEASURES IN CURRENT ECONOMIC SCENARIO

[Dr. Sanjiv Agarwal]

This is neither a festival bonanza nor a diwali blast from Reserve Bank ofIndia. From common men’s perspective, Reserve Bank has given yet another blow (this time thirteenth in succession in last twenty months) by hiking interest rates by 25 basis points on the eve of diwali. The objective is to curb inflation (being unsuccessful in last twelve attempts) but it has certainly dampened people’s festive mood. However, policy also hints that there may not be further interest rate hikes.

Addressing Inflation and Growth

Government and the central bank, both have miserably failed in containing inflation which, ideally can not be left to run loose. In the present scenario, when there is slackened global economic environment, slower economic growth and lack of strong financial reforms, a rise in interest rates will not help much but is likely to dent the economic growth without putting a break on inflation.Indianow projects an economic growth of around 7.6 percent, down from 9 and now 8 percent. One needs to appreciate that interest rate alone will not be able to control inflation caused primarily by high commodity prices. It will happen only when it is coupled with global oil prices softening, subsiding of food prices and enhanced food supply, manufacturing sector growth and reduced fiscal deficit. Higher interest rate will take a toll on economic growth which will soon become counter productive. Another problem is that regulators have now become astrologers as they forecast that inflation will come down to 7 percent by March 2011. How? There are no answers to it. Actually, growth is moderating on account of cumulative impact of earlier monetary policy actions and other factors.

Global crude civil prices are also expected to rise which will force go government to hike fuel prices further. This will only add fuel to inflationary fire. Also, higher interest rates will also be passed on by manufactures to consumers adding to inflation. If one believes in RBI’s hint that interest rates may not be hiked further, it leads to the believe that inflation may come down by March, 2012 and that interest rates are nearing the peak. If this turns out to be true, investors may even choose to invest in fixed deposits for medium term (say one to three years) as it may fetch a rate of interest which may not be available over next few months or years. In such a scenario, investors should also avoid locking in fixed rate home loans as it would imply higher interest outgo. However, it is expected that banks may offer one more rate hike on deposits as well as advances in next few weeks.

Higher interest rates on housing loans is expected to further harden the problems of real estate sector, though they may not reduce the prices of unsold inventory significantly. Credit off take is already slowed down and new projects are being deferred. Not only this even the primary market activities have slowed down and stock markets are behaving erratic with huge volatility. High interest rates, international turbulence and inflation will keep the markets volatile.

Freeing of Saving Bank Interest

The only cheers brought in is by way of freeing of saving bank interest rates. Though two competition among banks will lead to some hike in saving bank rates by 2-3 percent, it will make funds costlier for banks, shrinking their net interest margins and adding to pressure on profitability. This will also make loans costlier. It will affect banks with large saving banks account more. However, every bank will have to offer uniform rate on saving deposits upto Rs. one lakh. We may see few interest rate slabs without any discrimination from customer to customer.

While some banks have already hiked interest rate on saving bank accounts to 6 percent p.a., which would mean that their interest cost (cost of saving bank funds) will go up, they would be playing a gamble of attracting more accounts and funds in such savings which is certainly cheaper by 3 percent or more from fixed deposit funds. However, in banks with large saving bank accounts (SBI, PNB, BOB etc.), rise will impact their net interest margin and profitability. If profitability has to be maintained, advances will have to cost more or banks will have to scout for more avenues of non-interest income and treasury incomes.

InIndia, about 75 percent of the total savings deposits are held by public sector banks. Among PSBs, saving deposits comprise 36% in State Bank ofIndia, 31% in HDFC, 29%, in Punjab National Bank, 21% in Bank of Bank, 9% in Indusind Bank and just 3 percent in small banks like Yes Bank. So any increase in rates will impact them significantly, more so as their primary business is lending only. In contrast, private and new banks have a low saving deposit base and an increase of 2-3 percent will not impact them much. It is felt that given the large base and spread of branch network of public sector banks inIndiaand the convenience PSBs provide to customers, a rate difference of 1-2 percent may not affect deposit of public sector banks.

Though almost all banks will enhance interest rates, some of them with big corporate banking base may offset such impact by hiking fee for other services, transaction charges, commission, or offset by bringing in a higher minimum balance concept to enjoy float of low cost deposit.

Another significant change in saving bank rate would be that such interest rates would no longer be static but may tend to move in consonance with policy rates or market driven rates. All in all, customers are going to benefit, so far as saving bank interest income is concerned as no bank can now take saving bank depositors for granted. 

Removal of Prepayment Penalty

Another major step taken is towards removal of prepayment penalty on home loans so that if one opts to prepay to avoid interest burden, he may not be penalised, just because he is making a pre payment. On pre-payment charges being removed, benefit will be only to those select few who are in a position to repay before time ,ie those with some windfall liquidity or profit which are not of much needed at this point of time. Only a small percentage of home loans gets prepaid and a removal of prepayment charges (1 to 2 percent) may not lure a general home loan customer to prepay. However, it may lead to some increase in inter-bank shifting of loan accounts as ‘takeover of loans’ may increase.

Alternative Tools to Curb Inflation

It is also the time for RBI to think at alternative tools to curb inflation as the interest rate mechanism has failed to cure the menace. Like in medicine, if paracetamol tablet doesn’t control fever, doctor ought to administer other dose of medicine, similarly RBI should now look at other means such as selective credit control to some sectors by using credit risk weightage so that funds could be controlled from going into undesirable sectors or more use reserve ratios to have restrictive impact on inflation.

RBI alone can not curb the inflation unless it is supported by government in addressing supply side bottlenecks in agricultural producing, commodities and food prices and related infrastructure. Also, inflation, interest and growth, all can not subsist together. Both inflation and interest rates will have to come down if economic growth has to move up.

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