The Hindu Business Line : Banks red-carded

Over the past 18 months the Reserve Bank of India has repeatedly raised interest rates and adjusted reserve ratios to control liquidity with banks and, in turn, the demand for credit to confront what it perceives to be the central problem with the economy — inflation. Acting on these cues, commercial banks have pushed up the interest rates for both deposits and loans into double digits. The jury is still out on the battle against inflation but one of the intents of the RBI's monetary policies surely has been to make credit more expensive just as deposits have once again become more attractive. So why is the RBI not happy with the results of its repeated interventions to curb what it feels is runaway credit growth?

Early this week, the RBI urged banks to moderate loan rates even as they continued to climb steadily both for deposits and loans. The steep rise in the "floating rate" on home loans has caught many borrowers on the wrong foot; many may bear the pain with a grimace and a tightening of their belt; but a few will simply go under, and the scar of non-performing assets will be on the banks. That advisory comes after many similar pleas by the Finance Minister that have so far fallen on deaf ears. The RBI's circular seems the last weapon in its armoury to curb the enthusiasm of banks to adjust interest rates to what they assume the market can bear. In a deregulated market, administrative fiat will not work and the central bank has to rely on moral suasion evident in its warning of interest rates and related costs turning "usurious". But the whole purpose of its tight money policy has been to make credit more expensive so as to curb excessive demand and that, it would seem, is working too well. The problem is that its intervention is not selective when the CRR (cash reserve ratio) is raised or the repo rate is revised. By making the cost of capital for banks dear, the RBI forces its borrower-banks either to raise cheap capital elsewhere or jack up their own lending rates across the board. Private banks are covering their bets both ways by raising resources in the market and interest rates regardless.

In the battle for funds through bulk deposits, private banks win with their higher rates. Given their ownership pattern, the public sector banks (PSBs) will fall in line faster with the RBI's advisory on loan rates. That would be a short-term solution for both PSBs and the economy in general. Given the massive investment needs of the economy in its next phase of growth, private banks are already expanding their capital base through debt and equity. PSBs can do so but only if their ownership pattern changes. That is far more important today than the RBI trying to undo its own policy effects.

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