Sunday, January 18, 2015

Interest rate cuts and lazy banking

The RBI's surprise 25 basis points repo rate cut early this week has been greeted with widespread enthusiasm by India's corporates. With banks expected to lower the rates in response to the central bank's rate cuts, the  belief is that this marks the start of an easy credit cycle. I am not sure whether the rate cuts would readily translate into lower cost of capital for borrowers in the short-term, for atleast two reasons.

1. The more substantial economy-wide impact of the rate cut will be felt when the overwhelming majority of corporate borrowers, the small and medium enterprises, have access to cheaper credit. This is unlikely to happen anytime soon given the circumstances. Hobbled by distressed assets and declining capital adequacy ratios, banks are likely to be averse to assuming riskier loans, leave aside providing them at cheaper rates.

2. There is a strong likelihood that the banks may find the rate cuts as an opportunity to atleast partially ease the burdens from their distressed balance sheets. The temptation to only marginally lower lending rates while proportionately lowering deposit rates would be high given the proclivity for lazy banking among the country's banks. A recent Business Standard article gave an indication of the dominance of risk-free margin (spread between 10 year G-secs and deposit rate) on the banking sector's pre-tax profits.

Update 1 (16/03/2015)

Despite two rate cuts by the RBI, none of the major banks have lowered lending rates, preferring to use it to shore up their distressed balance sheets. 

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