The transmission of monetary
policy and its influence on the rates of interests in the market seldom happen due
to certain inherent weaknesses in the banking system and unless and until they
are removed, RBI cannot expect its monetary policy to be as efficient as
envisaged. There is a paramount need to reduce the interest rates of bank loans
and reduce the cost of funds in the economy to boost investment and production,
but the fact remains that banks are not in a position to effect any reduction
in interest rates due to some compelling reasons. Their Net Interest Margin
hovers around 3% which they do not want to touch what ever may be the
compulsions. Historically, banks get subsidized by depositors and the
government and the borrowers get subsidized by all stake holders. Since the base rate presently in vogue is not
based on a scientific calculation, its alignment with Whole Sale Price Index
and Consumer Price Index is a far cry. In such a scenario, the Public Sector
Banks cannot pass on the monetary policy changes as the dynamism expected of
them is missing and from this angle the
approach to marginal cost of funds is really good and appreciable and perhaps over
a period the banks may be compelled to accept professionalism to come out of
their weaknesses and remain in business in a healthy and dynamic manner. Some
beginning has to be made some where and perhaps the marginal cost approach
conceived by the Reserve Bank now can be the game changer. This is an
intelligent move and the banks will have to come around to comply with the
transmission of monetary policy in letter and spirit over a period.
The assumptions behind the
proposed guidelines that the rates of interests on various categories of deposit
are true and reflect the correct position of actual costs cannot stand scrutiny
on scientific lines. The rates of interest offered on Savings Bank deposits and
other deposits (though historic) are arrived at on a realistic basis cannot be
true as these rates do not reflect all the costs on an on ongoing basis and
there are several inbuilt costs which cannot be defined, identified and arrived
at easily. Besides the unhealthy competition among the banks compels them to offer rates which
cannot be entirely based on actual costs. The NRI deposits rates and the whole
sale deposits rates are based on competition, undercutting, and the concessions
offered on the advances rates and cash expenditures by way of incentives and
other forms to mobilize the deposits. The banks incur several costs on fast fluctuating fixed and variable nature and
their true position which should be reflecting in the cost of funds i.e.
deposits and borrowings is not reflecting is a ground reality. The major
example is the SB rate of interest. The banks seldom change the SB rates of
interest what ever may be the changes in the overall costs is a known factor as
despite deregulating the SB interest rate in the year 2011, the rate has not
changed in any of the PSBs. There is
absolutely no correlation between the real rate of return, inflation, and the
rate of interest on deposits. The equity capital which is comparatively cheap subsidizes the
rate of deposit to a great extent and this does not get into the calculation of
cost of deposit at least once in a while in our banking system. Similarly the
banks incur lot of expenditures in maintaining cash balances other than CRR balances with RBI and carrying heavy
accumulated bad debts which do not
appear to have been given any weight age in arriving at the marginal cost of
funds although it may appear to be there under unallocated expenditures. But
the banks in reality do not have any such calculation to fix the base rate as
it is always linked to the NIM in practice.
The one issue which cannot be ignored today is
that 38% of the term deposits are for a maturity of one year or less as per source
of funds mentioned in the notification. If we add 7% of Current Deposits and 21
% of Savings bank deposits, the total deposits of tenor one year and less would
work out to 66%. A deeper study will bring out the distortion that the profile
of deposits is still skewed towards short term, whole sale and high cost
deposits. If one studies the Liquidity Risk in the Risk Profile Templates
submitted to the Supervisory Committee on Risk Management of the Board of
Directors of Public Sector Banks, this aberration would be clearly visible. The
bodies offering such deposits do lot of arm twisting of bank officials and
instances are not rare where the latter have succumbed to paying as high a rate
as 11% for short term deposits when “aamaadmi” is paid lower rates for deposits
of the same tenor. Banks do incur other hidden costs as well to get these short
term and whole sale deposits. It is felt that such opaque aberrations only
derailed the recommendations of the Mohanti Committee Group on base rate. The
situation would not improve if the concept of marginal cost is introduced
unless measures are in place to capture all the actual costs to mobiles the
deposits. It would therefore be desirable to evolve a system to factor into all
costs and then go in for the weighted average cost of all
deposits up to and including one year instead of card interest rate of retail
and whole sale deposits.
The cost on borrowings also needs
to take into account domestic borrowings cost and external borrowings cost
separately as the composition between the two varies and the complexities
differ. While the cost on domestic borrowings can be easily compiled, the cost
on external borrowings can vary inter-alia depending on the Exchange rate and
Libor fluctuations. It is doubtful as to whether all our banks have graduated
themselves to have an assessment of the volatilities in the markets and factor
them into the calculations while arriving at the cost of raising both deposits
and borrowings.
The other point that should be
considered is the negative carry in CRR and SLR,
which again may tamper transparency for the ordinary borrower trying to
understand the intricacies of how his lending rate is fixed. A study could be
made on the impact of 7 % Current Deposits having no interest cost and 21% of
Savings bank deposits where the effective cost to the banks is less than 3% and
whether or not it will match the negative carry on CRR and SLR.
The inherent weaknesses which
need to be recognized and minimized if not totally eliminated from the banking
system to get an actual marginal cost broadly relate to preferred and favored
credits, administered rates of interests for certain categories, write off of
loans under political compulsions and otherwise based on contacts, influence and interference
from various corners, lack of understanding the concept of monetary policy and
its objectives particularly at operational levels, fudging and window dressing of balance sheets with
the active involvement of top managements and auditors, general laxity in the
professionalism in the conduct of Asset- Liability and risks management,
regulatory forbearance and supervisory relaxations taken for granted and the
human resources management with adaptability to the technological changes to
ensure efficient customer service taking into account the external factors of
competition in the whole business of banking. This definitely calls for an
immediate, careful and very serious consideration so that the banking becomes
responsive and sensitive to changes in monetary policy. The presence of Payment
banks now licensed and small banks in the offing may again change the landscape
making the position extremely difficult for PSBs in particular to be in a
healthy business environment.
Thus Base rates should be fixed
on the basis of:
1)Weighted average cost of all
deposits arrived more or less on a dynamic basis and of tenor one year and
less.
2)Unallocatable overhead cost
with transparency and justification
3)Average return on net worth
with transparency
4) without having any linkage with the NIM already
fixed.
Lending costs charged by banks to
borrowers should be fixed on the basis of:
1Base rate
2Product specific Operating cost
3Credit risk premium and
4Tenor premium
Basically, base rate should
reflect the actual cost of funds, the risk margin and the rate of return to the
bank but its sanctity lies exactly in arriving at the exact cost of funds and
the transparency in its computation and application. The computation of base
rate is expected to be on a uniform basis and apparently it leaves no scope for
manipulation to be fair to the borrowers .NIM should be the end result based on
operations and efficiency of the management.
Dr T .V.Gopalakrishnan
