As RBI seen pausing,banks may now cut rates

While the RBI has cut its main lending rate by 425 basis points in six steps since last October,prime lending rates of five major commercial banks have only fallen by about 180 basis points in the same period,according to HSBC,limiting the stimulative impact of the central bank moves.

The RBI on Tuesday pressed local banks again to pass on lower rates to consumers,and there were some signs that lenders may follow suit.

After the policy review,ICICI Bank,the country’s biggest private lender cut its lending rate by 50 basis points,and State Bank of India said it plans to take a decision to reduce rates after a meeting in the near term.

“The entire policy had that one message,so it is quite a strong signal. Banks’ lending rates can fall by 100 basis points,” said Sonal Varma,an economist at Nomura.

As the global economy worsened,Indian lenders have grown more cautious about extending new credit. Bank loan growth fell to around 17 per cent by end March from a peak of 29 per cent in October,with industry and services showing the biggest declines.

With external demand for Indian goods slowing,that has hurt attempts to shore up domestic demand. Exports have fallen for five straight months,industrial output has declined and the central bank has lowered its economic growth forecast for 2009/10 to 6 per cent,the weakest in seven years.

BANKS IN A BIND?

Banks have cited rising bond yields,concerns about worsening asset quality and volatile cash conditions in the money market as major deterrents to passing on rate cuts.

But the RBI says it has addressed each of those concerns. In addition to deep rate cuts,it has flooded the banking system with $84 billion in cash through various measures and has relaxed some rules on the way banks must classify their assets.

It has also been buying back bonds from the market to counter rising yields,which threaten to undermine its rate easing.

“The central bank’s focus remains the actions of the commercial banks,as it attempts to deliver a greater real economy bang from the policy rate buck,” Robert Prior Wandesforde,senior Asian economist at HSBC said in a note.

DEVIL IN THE DETAILS

In the aftermath of Lehman Brothers’ collapse in September,many banks in India paid higher rates for deposits in a mad scramble for funds. That has made it difficult for banks to reduce their lending rates without a sharp knock on profits.

As those high-cost deposits mature,banks will be able to reduce their effective lending rates by 100-150 basis points in the next three to four months and even match the RBI’s total cuts if the economy stabilises,HDFC’s Barua said.

Some bankers say that although banks’ benchmark rates have not moved in lockstep with the RBI’s,they have already cut lending rates for some of their best customers.

A tax-free rate of 8 per cent on small savings accounts and stiff competition among banks for deposits has also made them reluctant to cut rates in line with the RBI.

But with inflation near zero and growth set to slow further,banks’ lending rates will fall.

“Even when inflation is taken as 4.0-4.5 per cent based on the underlying trend,real lending rates still appear to be high,” the RBI said.