Banks may turn to treasury operations to boost profits

By Oommen A. Ninan

MUMBAI, APRIL 5. Treasury operations will now get a renewed focus by banks in view of the tightening of spreads, on account of the rate cuts announced by the Reserve Bank of India (RBI) at the beginning of this month.

``It is the right signal from the Reserve Bank for improving the operational efficiency of banks considering the interest rate risk management and asset and liability management for ensuring proper liquidity and also to enhance the value for shareholders present and potential as many banks are likely to go to the market as the Government's holdings are expected to come below 50 per cent,'' said Mr. K. Kannan, former Chairman of Bank of Baroda.

Last Saturday, the RBI had announced a series of interest rate cuts. The Bank Rate was reduced by one per cent, the cash reserve ratio (CRR) by one per cent, the repo rate by one per cent and savings bank deposit rate by 50 basis points.

The banks are likely to increase their focus on non-interest income such as charges for remittances, commissions on LCs and guarantees, trading profit on securities and foreign exchange transactions in order to protect their bottomline.

This will be particularly important in view of the shift in focus from mere business growth to increase in shareholder value. Since a number of banks are likely to hit the capital market for shoring up their capital base, the focus on shareholder value will become more of a necessity than anything else. If banks are able to increase profitability without too much of a growth, particularly in fixed deposits, this would be seen as a positive development by shareholders.

The cut in Bank Rate and CRR will activate the government securities market in a big way and banks will look at finetuning their treasury operations to participate and benefit from trading in government securities.

With the cut in interest rates announced, the yield on government securities will come down and the activity in the securities market will pick up. The yield at the long end is likely to come down by 25 to 30 basis points and the yield at the medium end is likely to fall by 50 basis points. The yield at the short end, that is one to two years, is likely to fall more sharply by about 100 basis points. The sharp fall in yields at the short end can be attributed to the fall in call rates which has a direct correlation with the yield on shorter term government securities.

The cut in CRR will greatly facilitate the borrowing programme of the Government. The gross borrowing programme has been pegged at Rs. 1,17,000 crores for the current financial year. In 1999-2000, about 75 per cent of the budgeted borrowing programme was completed in the first six months. ``If a similar pace is set this fiscal, we could expect a monthly average of Rs. 15,000 crores to be issued during the first half of the fiscal year,'' said Mr. M. R. Madhavan of ICICI Securities and Finance.

The cut in Bank Rate will force banks to cut their lending rates, evidence of which is already available in the form of cuts announced by State Bank of India, Bank of Baroda and Bank of India. Other banks are likely to follow suit. However, since banks are already operating on very thin margins, the deposit rates too will be slashed in order to protect the spreads. The other two factors which would help banks to cut the deposit rates are the relatively low inflation rate which has been in the region of 2.5 to 3.5 per cent during the last 6 to 8 months and the relative unattractiveness of debt oriented mutual funds following the doubling of dividend tax proposed in the Union Budget.

The cut in interest rate on deposits is likely to be sharper than the cut in lending rates because banks will have to continue servicing their sizable existing deposit accounts contracted over the years at relatively high rates. It will not be surprising if banks reduce the penalty on foreclosure of costlier fixed deposits contracted in earlier years. Some banks may even go a step further and waive the penalty altogether.

Since the rate on savings bank deposits has been reduced by half a per cent, banks will aggressively try to promote these accounts. The other benefit for banks is the fact that the revised rate of 4 per cent will be applicable to existing deposits as well.

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