RBI credit policy: Ball in banks' court

Bankers have to clean up the NPA mess and lend at reasonable rates to kick-start the investment cycle.

The credit policy announcement for the new financial year by RBI Governor Raghuram Rajan has been momentous. In addition to the repo rate cut by 25 bps to 6.5% which was on expected lines, the initiatives taken by the Governor to address to the ‘liquidity woes’ of the bankers have been stupendous.

Consumer Price Index inflation (CPI) at 5.2%, crude oil prices at less than $40 per barrel, fiscal consolidation by the Central government, arresting of fiscal deficit at 3.9% of GDP for FY 2016, sticking to the tough stance of 3.5% deficit target for the present year, have all prompted Rajan to reduce the repo rate, which is the rate at which the banks borrow from the RBI. Favourable macros coupled with the government reducing the interest rates on small savings enabled the Governor to successfully perform an “angioplasty” on the liquidity blockages.

Transmission of the rate cuts by the banks were not happening in tandem with the repo rate cuts. The Governor has cumulatively reduced the rate by 150 bps during the last 15 months, but banks have passed on only a paltry 60 bps.

Reasons cited by the banks are liquidity crunch and the burden of non-performing assets (NPAs). While the former is systemic, the latter is mostly self-inflicted on account of bad lending to the power, infrastructure, telecom, aviation and real estate sectors.

Based on the RBIs diktat, banks are now ‘cleaning up’ their balance sheets by coming out with the true position of the NPAs so that a “proper medicine” can be administered in the appropriate doses. The bane of stressed assets is being addressed with their sale through the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, one time settlements, strategic debt reconstruction (SDRs), including periodic asset quality review (AQR) monitored by the RBI.

Bankers have been continuously harping on the liquidity crunch in the market which was posing three problems. First, the absence of cheap funds to lend to corporates, industries and to retail loans such as automobile and housing, which have a multiplier effect on savings, investment and employment. Second, paucity of funds leading to fixed deposit becoming costly. Third, not being able to transmit the RBI cuts to the ultimate borrowers at “affordable” rates on account of the paradox of high cost deposits leading to high cost lending.

To overcome this vicious cycle of “liquidity trap,” Rajan has brought in a slew of measures in the process of moving from “liquidity deficit” to “liquidity neutral.” This will ease liquidity pressure and will enable banks to access their own cash balances at a lesser interest rate. Banks can now retain 90% of their daily CRR requirements.

Reverse repo rate

The policy has slashed Marginal Standing Facility rate (the rate at which banks can borrow short term funds overnight from the RBI against government securities upto 1% of
their aggregate deposits) by 75 bps to 7%.

In a direct attempt to reduce the rate corridor, the RBI has also increased 25 bps in the reverse repo rate (the rate at which RBI borrows from banks) to 6%. To demonstrate his commitment to ease liquidity stress, the Governor announced purchase of government securities to the tune of Rs 15,000 crore through open market operations.

The problem of liquidity has also aggravated on account of huge unspent cash balances of the government with the RBI to the tune of Rs 1.5 lakh crore, while shocking is the cash balances of around Rs 60,000 crore with the public. The former will get channelised in spending on infra projects, especially stalled ones amounting to a whopping Rs 8 lakh crore, and the latter to saving instruments once the rates get stabilised.

RBI has already introduced the MCLR (marginal cost lending rates) by the banks with effect from April 1. MCLR is decided on the cost of deposits plus loading of tenure premium and will have variable rates for both deposits as well as loans.

MCLR will not only avoid asset liability mismatch but will facilitate quick transmission of the rate cuts. This will reduce both the deposit rates as well as lending rates. Since the last one week, there has already been a reduction in 20 bps in the lending rates offered by the banks on housing and vehicle loans.

In sum, the government, by reducing the interest rates on small savings, and the RBI, by reducing the repo rate by 25 bps, narrowing the liquidity corridor by reducing MSF and increasing the reverse repo rates, have granted all the boons that the bankers were clamouring for. Bankers have to now seriously clean up their NPA mess and lend at reasonable rates to industries to kick-start the investment cycle in the economy.

The Ugadi bonanza granted by Rajan will be shortlived if banks do not seamlessly transmit the rate cuts and lend aggressively with the fond hope that there will not be an El Nino effect this year.

(The writer is a Bengaluru-based banker)