Why Bank Cannot Reduce Interest Rate On Loan

Why are banks not cutting lending rates?

Business Line--RADHIKA MERWIN

While banks have been citing the liquidity crunch for their inaction, they have been parking more than the mandated funds in government securities.
June 7, 2013:  
Vexed with banks for not cutting their lending rates, RBI officials on Friday indicated that the bank may cap its open market operations which inject liquidity into the system. This is intended to push banks into relying less on the RBI, and to lend more aggressively.
While banks have been citing the liquidity crunch for their inaction, the high proportion of government securities in their investment portfolio have a different tale to tell. Banks essentially have been parking more than the mandated funds in gilts.
The repo rate, the rate at which RBI lends to banks, was cut three times in 2012-13, a cumulative reduction of 100 basis points. However, this rate cut hasn’t been fully passed on to borrowers in the form of lower lending rates. Base rates, the rate to which all lending rates are linked, have only come down by 30-40 basis points.

WHERE IS THE ANOMALY?

But the banks’ problems do seem quite real too. While loan growth slowed to 14 per cent this year, deposit growth has been even lower at 13 per cent. Thus a large portion of such deposits (77 per cent) has already being lent out.
A higher credit-deposit ratio not only constraints banks from increasing lending further, but also limits the scope for reducing deposit rates. Thus banks are not able to effectively lower the cost of funds when the RBI reduces the repo rate.
Yes, close to 30 per cent of the deposits is invested in government securities as against the current requirement of 23 per cent. Hence, bank can liquidate their investments in government securities and increase their lendable resources. Why have they not done so?
One, while the RBI’s repo rate cut did little for lending rates, it had a significant impact on the yields of government securities. The 10-year G-sec gained 16 per cent over the last year. This has in turn added to the banks’ treasury income, making up for some of the moderation in interest income. Liquidating G-secs will mean that banks lose out on this income.
Two, banks have been holding on to liquidity because new deposits have been hard to come by. In fact, the investment-to-deposit ratio has remained at 30 per cent levels for the last few years.
On the other hand, increasing risk of loan delinquency has seen banks go slow on new loans too. Thus, while some of the liquidity crunch for banks can be eased by selling excess government securities, higher lending risks may still limit the rebound in credit growth.
Given these constraints, any action by the RBI to further curtail liquidity can hurt banks.
Till last month, the liquidity deficit continued to remain high. Banks’ borrowing through the liquidity adjustment facility (LAF), which helps them to manage temporary mismatches, still remains above RBI’s comfort level of 1 per cent of net demand and time liabilities (NDTL). The RBI announced open market operations for purchase of G-secs to the tune of Rs 7,000 crore on June 7.
http://www.thehindubusinessline.com/industry-and-economy/banking/why-are-banks-not-cutting-lending-rates/article4791992.ece