Last year 2014, RBI governor Raghuram Rajan had conducted 6 monetary policy reviews and each time refrained from any reduction in the repo rate [commonly termed as the policy rate] – interest rate at which the apex bank lends money to commercial banks.
Each time, governor argued that the underlying fundamentals primarily retail inflation [represented by consumer price index (CPI)] were not such as would warrant reduction. Pertinently, even in December, 2014 review when CPI was at a low of 4.3% in previous month or almost half of the 8% target set by RBI for January, 2015, he did not budge.
In 2015 however, Rajan has given up his stubborn stance having reduced the repo rate three times by 0.25% each in January, March and June respectively. The reduction in March was unscheduled coming outside the customary monetary policy review. This partly reflected the pressure building on him from finance ministry which wanted RBI support in government’s efforts to boost growth.
The above triggered all round expectation that banks would bring about a corresponding reduction in the lending rate. But, this has not happened. While, several of them have not obliged, even those like SBI who did, restricted the reduction up to 0.25% against cumulative cut of 0.75% in repo rate. So, first it was governor who delayed the much needed push and now the banks are putting spanner in the works.
Ironically, banks do not buy the ‘automatic transmission’ theory. From a banker’s perspective, the rate at which it can lend money is a function of the cost at which it garners funds [vide deposits of different maturities and money lying in current and savings account (CASA)] plus a margin to cover the cost of intermediation. Unless, this cost is reduced which banks opine, has not happened; they won’t reduce the lending rate.
The aforesaid explanation offered by banks is not convincing as nothing could have prevented them from undertaking reduction in the deposit rates [unlike the past, today banks enjoy full flexibility in fixing these rates]. With inflation on a downward trajectory, even after lowering of nominal rate, they would have protected the real return on deposit hence, no apprehension that depositors would be discouraged.
The banks also complain of being hamstrung by existing liabilities. This argument too does not hold water. A prime job of asset-liability committee is to keep an eye on trends in inflation, shuffle their deposit basket and re-price where ever necessary. In de-regulated policy environment, it is imprudent for them to wait for RBI to signal. A change in policy stance by the apex bank is merely suggestive but action on specifics lies with the banks.
But, all of the above volley of explanations amounts to nothing more than skulduggery. The sole reason as to why banks are not passing on the relief to borrowers is increase in their gross non-performing assets [GNPAs] to perilously high levels. GNPAs for banking sector as share of total advances increased from 4.1% in March 2014 to 4.5% in September, 2014 and further to 4.6% in March 2015.
According to bi-annual Financial Stability report prepared by a sub-committee of Financial Stability and Development Council (FSDC), while the GNPAs may increase marginally to 4.8% in September quarter of current fiscal but thereafter, it will improve to 4.7% by March 2016. However, under a worst case scenario where improvement in macro-economic fundamentals does not sustain, this could be much higher at 5.9%.
Banks also have on their books loans which are on verge of becoming NPAs but salvaged via restructuring that involves relaxing the tenor, granting moratorium on repayment and reducing interest rate. This is like putting the patient on the ventilator from where he may not easily come out. A restructured asset is perceived to be as bad as NPA and that is the reason why from April, 2015, RBI has made ‘provisioning’ for the former at par with latter.
The GNPAs plus standard restructured loans or so called ‘stressed’ assets increased from 10.7% in Sept, 2014 to 11.1% as of March, 2015. For public sector banks [PSBs] alone, these are much higher at 13.5% as against 4.6% for private sector banks. The stressed assets projected to be in the 12 – 15% range present a horrendous scenario!
In a situation where nearly 15% of money lent by PSBs yields zero return [there is not even an assurance that principal amount is recoverable], banks are bound to keep lending rate high as someone has to pay for these stressed assets. They won’t even be able to pass on benefit of reduction in deposit rate. Under these circumstances, to think of automatic transmission [and Arun Jaitely/Rajan goading banks to lower rates] will be an exercise in self-delusion.
There are 4 major reasons for this sordid state of affairs. First, slow down in economic growth during the last couple of years has affected ability of corporate to generate cash to service loans. Second, under diktat from government, PSBs resorted to indiscriminate and excessive lending to infrastructure projects especially power, roads, highways etc which got stuck in the maze of approvals [land, environment etc].
Third, these banks were forced to grant farm loan waivers and participate in restructuring of state electricity boards (SEBs)/power distribution companies (PDSs) involving a substantial haircut. Fourth, they gave loans to certain corporate/businesses in a totally ‘discretionary’ and ‘arbitrary’ manner without due diligence and assessing the viability of projects. One can discern an inevitable element of quid pro quo and corruption in such cases.
The issue of rate cut cannot be viewed in isolation from dire need to make a frontal attack on all four fronts. Team Modi is already working on first and second in a missionary mode. As a result, growth has revived and will accelerate as stuck projects start moving. On third, while RBI has ruled out any loan waiver, as regards SEBs/PDCs power minister has outright rejected any more bail out. On fourth, this government has zero tolerance towards corruption and meddling in affairs of PSBs. It is using all available means to recover the money from wilful defaulters.
However, all this will take time to yield desired results. Till then, banks cannot be allowed to bleed. Even so, they need to have adequate capital to be able to support project implementation [if unclogged projects now do not get funding, that will be a big set-back] and pick up in growth. Therefore, for now and next couple of years, government will have to seriously consider giving budgetary support for re-capitalizing PSBs as per a clear-cut road map.
The process of re-capitalization must be front-loaded. It should start during the current fiscal itself. Jayant Sinha, minister of state for finance recently alluded to giving Rs 20,000 crores; this amount should be immediately released to give desired comfort to PSBs. The likely negative effect of this on fiscal consolidation will be more than offset by increase in tax collections enabled by higher growth.
In the long-run, to ensure that problem of NPAs does not recur, the government should implement reforms of PSBs on the lines recommended by P Nayak committee. It should reduce its holding to below 50% and vest the residual shares in a bank investment company (BIC). The BIC dispensation will bring in private participation, restore full autonomy to management and ensure that banks are run on professional lines.
In short, all actions of the government should be galvanized to help Indian banks turn financially sound and have requisite capital to meet requirements of a fast growing economy. This would also ensure that the credit needs of industry and trade are met in a cost effective manner while at the same time, giving a fair deal to the depositors and other investors.