Why do banks obsess about interest margin?

According to the Economic Survey 2012-13, on average, households accounted for nearly three-fourths of gross domestic savings during the period 1980-81 to 2011-12. The share declined somewhat in recent years, and in the period from 2004-05 to 2011-12, it averaged 70.1 per cent of total savings.

Further, the ratio of household savings to GDP (at current market prices) climbed down from 25.2 per cent in 2009-10 to 22.3 per cent in 2011-12.

However, what the Survey notes as a rather disturbing feature is the crash of financial savings of the household sector as a proportion of GDP (at current market prices) to single-digit 8.0 per cent in 2011-12, the lowest since 2004-05 with the simultaneous gain in the savings ratio in physical assets to 14.3 per cent in 2011-12, the highest ever since 2004-05 (see chart).

Savings deposit rates

Much of the financial savings of the household sector are in the form of bank deposits (around 30 per cent in the 2000s).

The year-on-year (y-o-y) growth rate of aggregate bank deposits witnessed a massive decline from 16.51 per cent in 2011-12 to 12.87 per cent in 2012-13 (Q3).

The major factor responsible for this sorry state of affairs is the low deposit interest rates by banks despite high inflation rates, albeit slight moderation in 2012-13, which prompted the RBI to be a little accommodative in its monetary policy by way of reduction in policy rates.

Taking a cue from these cuts, several banks reduced their deposit and lending rates during the year.

As the Survey observes, the modal term deposit rates for banks across all maturities declined by 15 bps to 7.27 per cent during 2012-13 (as on 15 December 2012). The decline was noted across all bank groups.

The rates of interest on savings deposits, which were deregulated by the central bank effective October 2011, however, were generally stable. So far, no PSB has increased its savings deposit rates. Why? The savings bank holders probably need an explanation from PSBs.

The median lending rates on bank advances (at which 60 per cent or more business was contracted) ranged between 9.50 and 15.75 per cent in November 2012.

The above two paragraphs point to a huge Net Interest Margin (NIM), a luxury that is possible only in an oligarchic market.

It is understandable that banks reduced their lending rates; but why did they also reduce their deposit rates?

More specifically, what was the rationale behind banks, especially PSBs, to reduce their deposit rates particularly when (a) inflation rate had not become stable and (b) stock market was still volatile with (c) returns at moderate levels?

It is felt that since banks were flush with funds due to inadequate takeoff of credit despite rate cuts (reasons lay elsewhere) they did not want more deposits to accrue lest interest payments would have dampened down their NIM. NIM is a very crucial determinant of profits of banks. However, the intention was flawed and decisions were taken without keeping an eye on the future of the macro-economy.

Banks’ function

India is a bank-driven economy. The fundamental function of a bank is/should be financial intermediation, which assumes paramount significance, particularly when a disproportionate chunk of the population is un-banked and under-banked.

As referred to earlier, householders, comprising teeming millions of the middle-class, do not have other instruments as safe as bank deposits.

Protecting NIM is a secondary or maybe a tertiary objective of banks, particularly PSBs.

The situation warranted banks to keep their deposit rates at the same level even if it cost them higher interest expenses and lower NIM.

The obsession of banks to attain high profit levels through spread management exclusively led to sharp decline in savings rate, which is now reflected in higher savings-investment gap and shift from financial to physical assets, including gold, as a safe haven, the large-scale import of which is responsible for a bulging CAD.

Even if banks had to maintain their profitability, they should have looked at the other component, i.e., Burden Management.

However, sadly enough, PSBs cannot do much there because a significant chunk of operating expenses is “wages and salaries” which are commonly agreed by PSBs under the aegis of IBA, disregarding the abilities of different banks to meet their bills.

It is high time that banks switched to payment according to their abilities to pay and the risks they take.

The obsession with NIM must be abandoned, whether it is induced by the owners or because of the inelasticity or stubbornness of operating expenses.

Fee-based income needs to be augmented by taking advantage of technology. Anecdotal evidence indicates that banks are yet to pass on the benefits of technology to the customers fully.

Banks must keep the macro scene in sight before taking any decision on at least interest rate because in a deregulated regime, it is the interest rate that acts as the fulcrum for financial resource allocation.

In their annual reports, banks devote space to a write-up on the macro environment, but their concern is not reflected in their internal policies or the balance sheet.

Banks must shun their obsession with NIM and act, first and foremost, as financial intermediaries.

And that should be the mool mantra of PSBs, particularly if they are striving to accomplish inclusive growth through financial inclusion.

During the pre-Reforms era, banks had an obsession with market share whereas market share of deposits could be increased by simply hiking the deposit rates.

But would that be prudent? At present, the same obsession is being observed with respect to NIM. There are various other areas that banks need to critically look into.

(The author is a former commercial bank economist)

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