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Govt banks’ constraint in fixing interest rates

— FILE PHOTO

INTEREST IMBROGLIO: Finance Minister, P. Chidambaram with public sector bank chiefs.

On the face of it there is nothing exceptional in the recent meeting the Finance Minister had with the chiefs of public sector banks. Nor should it surprise anyone that the meeting, called by the government to discuss ways of increasing bank finance to industry at affordable rates, should have predictable outcomes.

Led by State Bank of India, the country’s biggest bank, practically all the PSBs announced a reduction in their prime lending rates. SBI’s PLR has come down by 0.75 percentage point to 13 per cent.

All other government-owned banks have fixed theirs around that figure. Their action on the prodding of the Finance Minister may seem routine but there are a few important issues.

The first issue has to do with their autonomy — how much independent are they in the face of pressures from their owner in commercial decision making? In all the PSBs, the government has the majority stake. That position will continue well into the foreseeable future.

Public ownership of banks gives them strength as recent events in developed countries have shown. The problem lies in the way government exercises control. In the instant case, should the government rather than the banks themselves decide their interest rate structure?

Earlier, the Finance Ministry was seen to be usurping some of the Reserve Bank of India’s legitimate functions. It had taken upon itself the task of monitoring liquidity.

After interest rates were deregulated, banks determine their interest rates, whether on loans or deposits, on the recommendations of their internal committees. Although across banks interest rates can vary, in practice they tend to be nearly uniform, at least among the PSBs.

This is because these banks operate in the same environment, have access to similar resources and most important and continue to be dictated by the government even in operational matters.

Hence, even though they compete among themselves, such competition tends very often to be of a non-price variety.

But none of this explains why the banks had to wait for the Finance Minister’s call to lower their rates. After all, there have been massive infusions of liquidity.

The RBI has also cut the repo rate signalling a lower interest rate stance. In the circumstances, the government’s efforts to reduce interest rates, though well intentioned, seem unnecessary and only underlie the inadequacy of PSBs. Do they have real autonomy?

Needless to add, the large network of branches, so assiduously built up by the government-owned banks in the heydays of branch expansion, is a source of strength. It has given them an unmatched edge over private banks.

The ongoing financial crisis has shown how valuable branches are to a bank. Retail deposits are more stable than wholesale deposits.

Large scale mobilisation of retail deposits is possible only by a bank having a large number of branches.

Both in the U.S. and India, banks which were mobilising retail deposits through a network of branches have survived the credit crunch better than those that were dependent on large wholesale (usually institutional) deposits.

In the U.S., ‘stand-alone’ investment banks such as Lehman Brothers failed partly because they relied almost entirely on wholesale deposits. Others such as Goldman Sachs and Morgan Stanley may now have to tap retail deposits to survive. On the other hand, banks such as Bank of America, though exposed to the crisis, have been resilient.

In India, ICICI Bank, the largest private sector bank, is seemed vulnerable. Although an important player in the retail segment, it depended on wholesale deposits to a great degree. That is an anomaly that its management will surely correct.

Curiously, not very long ago, having a large number of bank branches was considered a weakness.

It was to be remedied by encouraging banks to shut down some of their branches. Bank mergers so assiduously championed by the Finance Minister would have had the same result.

All these were sought to be justified in the name of profitability. However, without sufficient deposits, the business of banking cannot be undertaken profitably. And it is branches that bring in stable, retail deposits. Alternative delivery channels such as internet and phone banking have their roles but recent experiences characterised by low investor confidence reinforce the point that branch banking cannot be replaced by the newer delivery channels.

It has been well recognised that government ownership increases risk aversion. For the banking sector this means that banks will lend only, if at all, to their top rated borrowers.

In the context of the ongoing crisis and the consequent slowdown, risk aversion has acquired a whole new meaning. Globally the credit markets are frozen, with even top borrowers finding it difficult to raise funds.

At the same time, there is flight of capital to the safety of government securities, especially those of the U.S. government. (That partly explains the paradox of the American dollar remaining strong even as the economy slips into a recession).

In India, the PSBs already have a reputation of being risk averse partly due to the glaring deficiencies of their human resources and policies that discourage risk taking. Even in more normal times they were ‘credit shy’. The present environment is hardly normal.

Banks are deploying bulk of their resources in government securities. In the fortnight ended October 24, they invested more than Rs. 71,000 crore in government securities. A fortnight earlier they had invested Rs. 19,879 crore.

Besides, at a time the economy is markedly slowing down, larger lending by the PSBs will increase the level of bad debts, a point made by the SBI Chairman. Public sector bank chiefs, who are trying to implement the government diktat to lend more, have their tasks cut out. For one, they have to motivate their employees to lend under trying circumstances.

Two, they will have to be ready to support their staff when accountability issues for the bad loans are fixed.

C. R. L. NARASIMHAN

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