Letting go

A day after the Reserve Bank of India cut its key policy rate by 25 basis points, the Minister of State for Finance Jayant Sinha said he expected public sector banks to cut their lending rates by a similar amount. Since banks have been urging an easing in policy rates almost incessantly over the last year, it may, on the face of it, seem reasonable for the Centre to prod them to pass on the benefits of a cut to customers. Especially as only three PSBs have reduced their base rates — to which all lending rates are pegged — after the two rate cuts by the RBI this year. Others are still dragging their feet waiting for cues from the largest lender, the State Bank of India. Yes, there is no denying that poor transmission by banks, at a time when the economy is just reviving from a prolonged slowdown, is a matter of concern. But coercing PSBs into cutting lending rates is hardly the solution. This will only impede their freedom to take individual pricing decisions and run their commercial operations viably. The Centre’s suggestion that banks are indulging in anti-competitive behaviour also does not hold merit. The base rates of most PSBs are already on the low side, between 10 and 10.25 per cent, despite weak profitability and low returns.

Poor transmission of policy rates is hardly a new problem. The RBI’s primary tool for monetary signalling is the repo rate. While it helps set the direction for interest rates, banks decide lending rates based on their own base rates depending on the cost of funds, administrative expenses and profitability. Banks react differently to the RBI’s rate tweaks, but PSBs have been quicker to pass on rate cuts than their private counterparts. This is because unlike private banks, their PSU counterparts are under covert pressure to lower rates. In July 2013, after finance minister P Chidambaram had prodded PSBs to lower their rates, many ‘dutifully’ did so only to be in for a rude shock as the RBI suddenly hiked short-term rates through its liquidity tightening measures.

This time round, PSBs are more cautious and are biding their time. Muted credit growth and a high percentage of bad loans are already stressing margins; a cut in lending rate will squeeze them further. With the Centre now rewarding only more efficient banks with additional capital, the reason to improve profitability is even more compelling. Rather than depend on whatever little funds the Centre offers, it is prudent for banks to be committed to commercial discipline. The time has come for the Centre to provide full operational autonomy to PSBs. With a share of over two-third in loans, it is imperative that these banks are well-capitalised and operationally strong enough to meet the credit demands of a reviving economy.

COMMENT NOW