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Interest rates may firm up: Survey 'Forex reserves accretion slowing, credit offtake keeps rising'

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  • Financial health monitor
  • Case for RBI to unwind MSS for better liquidity.
  • Credit surge calls for adequate safeguards.
  • Banks need more capital to meet Basel II norms.
  • RBI norms on hybrid instruments will help
  • Our Bureau

    New Delhi, Feb. 27

    Lending rates could be on an upward curve on the back of tightening liquidity, the Economic Survey has said. "A slowdown in foreign reserve inflows relative to earlier years and a growing tempo of credit off-take may exert upward pressure on interest rates," the survey has said in its chapter on 'Monetary and Banking Developments.'

    In view of a likely tightening of liquidity, the survey has said that there might be a case for RBI to steadily unwind the market stabilisation scheme (MSS) "to release the required liquidity into the system."

    On the back of a steady surge in credit demand, the Survey has cautioned the sector on the possible negative fallout of an excessive growth of lending without proper safeguards put in place to ensure quality of the loan portfolio.

    "Expansion in financial intermediation is generally associated with increased growth and efficiency. At the same time, excessive credit growth without adequate safeguards could lead to some erosion of credit quality," the survey added.

    Balance needed

    It said that the policy response to the increased credit flow would attempt to create a balance with credit quality and risks.

    "The policy, therefore, has to strike a balance between credit quality and the associated risks, while allowing bank lending to contribute to higher growth and efficiency," it is pointed out. The survey has said that banks would soon have to bolster their capital adequacy ratio (CAR) in view of the rise in credit demand.

    "In view of the rapid growth of bank credit, there may be a need for further capitalisation of banks and for developing strict management techniques/methods for the prudent evaluation of investment proposals."

    Recent guidelines

    However, it has pointed out that the recent RBI guidelines on raising perpetual debt instruments would help Government-owned banks to improve their CAR without diluting the Government's holding.

    "Recent guidelines issued by the RBI for raising additional capital funds through the issue of innovative perpetual debt instruments, without impinging on the Government equity structure in public sector banks, will help banks meet Basel-II norms," the survey has said.

    "So far banks have been able to finance the credit boom efficiently with a CRAR of 12.8 per cent, considerably higher than the 8 per cent BASEL norm and 9 per cent RBI stipulation.

    But by end-March 2007, banks are required to conform to Basel-II norms and this will require additional capitalisation," the survey added.

    (This article was published in the Business Line print edition dated February 28, 2006)
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