ANALYSIS. Why banks haven’t followed RBI to cut rates

For all the hullaballoo over the RBI’s reluctance to cut rates in the past year, there has been very little action on the ground by banks after the RBI’s surprise cut of 25 basis points in key policy rate, made a week ago. Barring two public sector banks - Union Bank and United Bank - who cut their base rates by 25 basis points in the past week, others are still dragging their feet and waiting for cues from State Bank of India - the largest bank in India.

But unlike in the past when public sector banks have been more aggressive and nippy in passing on rate cuts, muted credit growth and higher stress in the system are likely to weigh on their decision this time around.

PSU banks at the forefront

A look at the data put out by RBI on banks’ lending rates since 2008, shows that public sector banks have been more active in passing on RBI’s rate actions than their private counterparts.

Consider for instance, the period between September 2008 and September 2009. The RBI had cut the repo rate by a steep 425 basis points during this period. On an average public sector banks lowered their lending rates by 128 basis points during this period, while private banks cut their loan rates by just 60 basis points.

Or the period between March 2012 and June 2013, when repo rate was cut by 125 basis points. While PSU banks cut lending rates by about 30 basis points, private banks in contrast raised their rates by 30 basis points.

Why the disparity

This difference could be due to a couple of reasons. One, while strong operational performance and higher share of low cost deposits has helped private banks hold their margins steady, they also appear to be tight-fisted in passing on rate cuts, to keep their margins intact.

Two, during a rate cut cycle, the overall risk in the system is usually higher. In the current scenario for instance, the economy has been in a protracted slowdown, and banks thus yearn for a higher spread to compensate for the risk. Private banks in particular have been quicker to assess the risk as also to price it in. To keep spreads higher, these banks would not lower their lending rates in a hurry.

Aside from the lax risk assessment systems in public sector banks, a tacit pressure from the government has also forced them to lower rates in a hurry. In July 2013, the then finance minister P Chidambaram had urged public sector banks to lower their base rates. This was because even after the RBI cut its repo rate by 125 basis points since March 2012, banks had cut their lending rates only by 20 basis points.

Many public sector banks dutifully reduced their base rates, only to face a rude shock when the RBI suddenly hiked short term rates through its liquidity tightening measures a few days later.

Waiting for cues

But this time around, public sector banks may have a lot to consider before they start to cut rates.

For one, the bank credit growth has slipped to 10 per cent in December 2014. A cut in lending rate will stress margins even more for public sector banks, already struggling to keep their margins intact.

Two, with stressed assets at over 10 per cent of loans, public sector banks are already earning lesser income on assets, thus impacting margins.

While many banks have lined up meetings of their asset-liability committees this week, to review their lending and deposit rates, all eyes are on SBI, which was the first to lower its deposit rates in September last year.

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