Yet another monetary policy review by the RBI is over and as usual there was speculation whether policy rates would be reduced this time. There was demand that policy rate (repo rate) should be reduced as there was muted GDP growth and such reduction of repo rate will improve credit offtake, investment and growth.

But the RBI sensibly decided to continue with the status quo. It is a misconception to expect that banks lending rate must move in tandem with repo rate. People fail to understand that banks predominantly lend out of deposits mobilised and some amount of market borrowings. Banks borrow from the RBI under the repo rate to meet their day-to-day short fall. The repo rate is applicable for overnight borrowing from the RBI against Government securities.

To highlight the impact (or non-impact) of the repo rate on lending rates by banks, consider the following position of banks as on September 1, 2017. Banks have lent ₹80,139 billion, out of deposits and borrowings of ₹1,10,401 billion. Borrowing under repo rate from the RBI was hardly ₹26 billion on this day.

Reduction in repo rate is only an indication to banks to reduce interest rates; they have to start by reducing interest rate on deposits first and then on credits. This will take time and will lead to losing the deposit base.

It is anybody’s guess that reduction in lending rates will improve investment. As long as any venture can produce goods and services that can be sold with a profit, investment will take place. What ultimately matters is Internal Rate of Return for an investment. When the cost of material, overheads, etc. can be passed on to the consumer, why not the cost of capital? Interest on borrowing is only a small cost in the entire chain of production, which can be very easily passed on to the consumer. Hence there is no case of this demand that interest charged by banks should be reduced to improve investment and growth.

Every bank has performing as well as non-performing assets. The good borrowers, who are servicing their debts promptly, are in a way penalised by higher interest, as banks cannot charge the defaulters and also they have to make a provision out of profit made from performing assets (read as honest borrowers). So if there are tough measures on the defaulters to make them to pay back, that will enable the banks to reduce their interest.

As depositors are not organised, they become an easy target for banks. When banks are not able to take action on their non-performing assets, they penalise the depositors by reducing interest on deposits. Banks must realise that without depositors, they cannot be in business. But the treatment to the depositors by the government, banks and all business lobbies is pitiable.

There are many senior citizens who are living on interest income from banks. Interest rate for deposit was 9 per cent some four years ago, which is around 6.75 per cent now. If someone was getting a monthly interest of ₹ 7500 on his deposit of ₹ 10 lakh, now he will be getting ₹5,625. This is a reduction of 23 per cent in his income. The Government and RBI must ponder over whether the price of essentials is reduced by this much during this period.

There are already signs of funds getting shifted from banks to mutual funds. If the banks and policy makers do not realise that somebody is ‘moving their cheese’ and act fast, they will be out of business in course of time and the commercial banks may have to become investment banks in future.

The writer is a retired banker

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