Banks not passing rate-cut benefits: India Ratings

Indian banks have not been passing on the rate cut benefits announced by the Reserve Bank of India (RBI). India Ratings put out a research paper on the same which was authored by Anand Bhoumik of India Ratings & Research.

Bhoumik told CNBC-TV18 that reliance of banks on short-term liabilities had been increasing which has led to margin pressure.
He added that over the years, loan tenures have increased and deposit durations have come down which increases the refinancing pressure. Almost 30-40 percent of deposits are for less than six month duration. That refinancing pressure is on the banks every six months. He stated that this was the reason why banks did not reduce short term deposit rates.  
Speaking on growth target for FY14 and performance in FY13 for banks, he said that the latter was a benign year due to reduced loan growth. He expected deposit accrual to be healthy this year as the headline inflation numbers have come down and deposit rates haven’t kept pace.
He expected the transmission numbers to be better only when there is a shift of their dependence on short-end to long end. Also read: Will policy shift to reverse repo lead to lending rate cuts Below is the edited transcript of his interview to CNBC-TV18. Q: State your case first; we repeatedly have the Reserve Bank of India (RBI) Governor at 11 o’clock announcing a rate cut and at 2 pm, the bankers gather and say that they do not see any scope of passing it on. What explains this, inability or unwillingness on the part of the banks?
A: This has been building up for a while. We have been observing that the reliance of banks on short-term liabilities has been increasing. That perhaps can probably be explained for reasons of margin pressure.
This is a reasonably fragmented industry. Banks have been very careful to be conscious of their margins being at the short end and the liability side may have helped their cost of funds case.
At a time, the overall reliance of the system on this (short-term liabilities) was relatively low. But over the years loan tenures have been increasing and deposit tenures been coming down. This means that the funding caps in the in the banking system has been increasing and the refinancing pressures have been going up.
This has build-up to a point where it becomes very difficult for banks to reduce the cost of deposits without impairing the flow of deposits. This has resulted in an increased reliance on certificated of deposits (CD), liquidity adjustment facility (LAF).
Apart from a diluted transmission of monetary policy, it has led to crowding out corporate from the CD market. Banks CDs dominate that market space and that is about 75-80 percent and it has lead to a flat yield curve.
So, there are multiple policy challenges which have now come about because of the funding pattern that banks have build-up. Q: What parameters you have seen in terms of deposit growth in the past couple of months and maybe even in the new fiscal in FY14. What sort of growth targets are you estimating on the credit front and on the deposit front going into FY14? Do you expect the significant mismatch to continue?
A: I think the FY13 in was a relatively benign year for banks because of reduced loan growth. The fall in credit demand had helped them because accruing deposits was a bit of a problem at a time when real interest rates were low.
That situation seems to have somewhat eased. Headline inflation numbers have come down, deposit rates haven’t kept pace and therefore, there are probably some real interest rates that lenders are seeing. So the deposit accrual this year would be reasonably healthy, in excess of last year’s numbers.
The question on loan growth will remain. Industrial activities are seeing a slowdown and therefore this year, the mismatch is between deposits and loans may be muted.
Our case is somewhat different. I do not think we are arguing on quarter-on-quarter or in the immediate near one year perspective. We are arguing from a more structural perspective. The share of long-term loans may not just fall off. Banks would continue to pump out a fair amount of mortgages in infrastructure.
Supply of long-term liability however, is limited to the top five-six banks and therefore banks need to be enable to raise long-term liabilities from the market and that would have to be a policy call that RBI would have to take.
_PAGEBREAK_ Q: One big argument that banks are not able to reduce their deposit rates has been that savers are not biting. That has got something to do with the inflation psyche or the inflation expectations in the system, isn’t it? What prevents banks from dropping even short-term deposit rates?
A: The reason why they do not do that -- you are right, part of that is also to do with the fact that real interest rates have been negative. Gold had seen such an attractive proposition and there were other schemes in the market which pulled out money away from bank.
However, the fact remains that the refinancing pressures on banks are high. Keep in mind that about 30-40 percent of deposits of banks are less than six months. This means that every six months they necessarily have to come to the market to refinance about third to 40 percent of the balance sheet.
That is a significant amount of pressure and this is just to maintain the existing book with loan growth thrown in. That is a fair amount of dependence that banks have.
The ability of the money market to supply that sort of short-term funds is also limited because the depth in the banking market is far more than in the bonds on the money market. So given this reliance, the short-term rates have just been so high whether it be in the money market or the bulk market. That refinancing pressure makes it difficult for banks to cut deposit rates. Q: Things might ease up a bit if inflation psyche changes? It has been consistently falling. One of the reasons why we have inverted yield curve, is that immediate liquidity is kept tight by the RBI deliberately in the inter-bank market. It is worried about the consumer price index (CPI) being close to double digits at 9 percent and thereabouts, current account deficit (CAD) pressures. So, if those were to ease and the inflation psyche and inflation expectation psyche is broken, do you think that will ease this pressure? Will transmission improve and how do you see it improving at all. How or when?
A: I think this will take time. There could be an expectation of a cyclical improvement as inflation eases off, but my worry is that it may not be the only answer. We got to ease out the banks’ dependence on short end liabilities and we got to shift the banks away from the short-end to the long-end.
One of the ways to do that is to enable them to raise long-term bonds, which surprisingly they cannot do in the rupee market though they can in the dollar market.