The Hindu Business Line : Fluidity in home loan rates

IF THERE IS one signal from the banking industry that sends borrowers or depositors into a tizzy, it is talk of an increase in the cost of funds mediated through interest rate hikes. In this age of competitive business, no other issue so divides banks and their consumers, exposed to ever-widening choices for borrowing or parking funds. For the past few years, the interest rate regime, by far the highest in a transitional economy, has been loosening up, with rates across the board dipping slowly but steadily. For the banking industry as well as consumers, that has been a mixed blessing and for entirely different reasons. While banks are pleased that their cost of funds is dropping (with the decrease in deposit rates), consumers are happy at the falling lending rates. This is reflected in the performance of banks in 2004-05, particularly in the volume and pattern of credit growth. The new segment of borrowing has come from retail trade and housing, with interest rates on the latter dropping to single digits. Is this the reason for signals from banks of a possible spike in housing loan rates?

The possibility of an increase in home loan rates was first indicated by HDFC but some scheduled commercial banks with large exposures to housing have taken a wait-and-watch approach and have stated that they do not intend to raise home-loan rates for the moment. Some banks have said that instead of hiking rates they would like to concentrate on improving credit delivery systems, reducing the cost of funds, and reducing the cost of deposits by moving away from bulk deposits to more sustainable retail deposits. While the situation on home loan costs remains fluid for the moment, the genie is out in the open and will tempt the industry in the near future.

Banks would do well to resist that temptation considering the medium-term prospects for the economy. Barring some unforeseen circumstances, it should perform at least at the level at which fiscal 2005-06 will close — that is, with a GDP of seven per cent. The housing sector will continue to play a dynamic role if that growth impulse continues pushing up bank credit growth. On their part, banks will continue their search for low-cost funds. The year 2004-05 set the trend when banks increasingly resorted to non-deposit resources — for instance, equity and international borrowings — to strengthen their capital base and meet the rising demand for funds. Access to non-deposit resources, therefore, will mitigate the negative effects of hikes in deposit rates, allowing banks to retain their margins.

There may be little ground for hiking housing loan rates for a related reason. Of late, the quality of bank assets has seen considerable improvement, with non-performing assets continuing to fall since 2003-04, a decline prompted by the creation of legislative options for recovery. The RBI has also put in place a credit risk management environment that should make banks less prone to losses on their asset side. By the same token, it should make them less prone to hiking interest rates for funds to the fastest growing segment in their credit portfolio.