Last week, Finance Minister Nirmala Sitharaman announced a raft of measures aimed at reviving the economy and boosting investor sentiment. As part of this package, the government announced that it would frontload the release of Rs 70,000 crore to state-owned banks for recapitalisation, and the linking of the interest rate on loans to the RBI’s key policy rate, the repo rate, besides promising bankers that they would be protected in cases where bonafide decisions are taken by them while lending. The upfront release of what is growth capital for banks should help lenders to plan their asset growth better instead of scrambling for funds and ensure that the pipeline of loans is healthy. But where the government, central bank and banks may be on sticky ground is on linking the interest rate on loans to the repo rate.
The rationale for pricing loans based on what is essentially an overnight borrowing rate is not clear, especially in the context of funding costs for banks. Ideally, such a benchmarking should be to liquid bonds or securities and across different average maturities or tenures such as three-months, six-months and one-year, like the London Inter-Bank Offered Rate or Libor. It’s a challenge that the RBI and the Indian banking industry have faced over the last few decades following the freeing up of interest rates after having tried out the base rate system and then a marginal cost of funds based lending rate. Similarly, it may be too optimistic to expect bankers to push loan growth in the absence of more credible assurances of protection from over zealous investigative agencies.
Essentially, some of the measures unveiled last week for the financial sector may prove only to be short-term balm. India’s banking industry, dominated by PSU lenders, will be competitive, more efficient and profitable only if there is a structural design change which features operational independence, empowered bank boards, better governance standards and quality of lending besides a government shareholder which acts like a sovereign wealth fund. That will have to be accompanied by stable government and regulatory policies. During its first term, the Narendra Modi-led government may have been late in addressing the problem of bad loans which forced the government to infuse over Rs 2 lakh crore for recapitalisation. A government with a powerful political mandate and facing the rising threat of a deepening domestic slowdown and global downturn, cannot be seen to be kicking the can down the road now.