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S. Balakrishnan

WOULD a manufacturing company make a product whose selling price is less than its raw material cost? Not likely, for the more the company produces, the more it would lose.

But, it would seem that this truth eludes our banks. How else is one to explain their interest rate structure for deposits?

A table published in Business Line (December 30) is revealing. Rates for the shortest maturity of 15-29 days average 5 per cent. Not much damage possible here as call rates have never dipped below 6 per cent recently and the RBI pays 6.5 per cent on the obligatory cash reserve maintained with it. Banks can still earn a spread on these funds. Rates for 30-45 days are only a shade above those for 15-29 days in public sector banks. But many private sector banks are already over 6 per cent (there are a few oddballs offering even more than 7 per cent; one pays 8 per cent).

The pattern continues with public sector banks in the 6.5 - 7 per cent range for 91-364 day maturities and private sector banks at levels of 8 per cent. Beyond one year, the differential narrows. Interest rates for over one and less than three years are around 8 per cent in the former and 9 per cent in the latter. Three-year deposits reflect a differential of only 0.5 per cent in general. When one traverses to longer maturities, it becomes difficult to understand the economies of present deposit rates.

Consider the following: Yields on 10-year Government of India securities themselves are currently only about 8.25 per cent, having risen somewhat after hitting sub-7.5 per cent levels. CRR yields 6.5 per cent. It is easy to see that, at the margin, banks would be losing money straight on long-term deposits if they are deployed in risk-free assets. That deposit rates still persist in the region of 8-9 per cent shows that old habits die hard - a reflection of the times when mobilising deposits without regard to cost and profitability was considered an end in itself. In fact, much of the branch network of public sector and old private sector banks becomes redundant if increasing deposits as a corporate goal gets less priority.

The sharp fall in bond yields has enabled banks to sustain to some extent their high cost deposits. After all, a 3 per cent fall in yields translates into no less than about 25 per cent appreciation in the prices of 10-year securities. With as much as 40 per cent of deposits invested in bonds, banks have made handsome profits from falling rates.

There is little scope for attractive returns from lending to the corporate sector. The `AAAs' are hardly interested in borrowing at the PLRs of banks; their benchmarks are money market rates and gilt yields. Commercial paper yields are almost on par with those on T-bills and spreads on corporate bonds are 150 basis points or so over corresponding Government bonds, barely enabling banks to break even on their deposit rates, leave alone cover fixed costs.

The more astute banks have, in fact, lost interest in corporate financing. They are focusing more on retail lending, which is a less interest-rate sensitive segment of the market and spreads could be of the order of 3 per cent for asset and mortgage financing and over 5-6 per cent for loans without collateral.

Planning the liability structure, mix and pricing as well as their asset counterparts is becoming increasingly crucial to bank profits given that interest rates are completely market-driven. Only those who get these right will survive in the long run.

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