Mumbai, May 2, 2013: India Ratings & Research (Ind-Ra) expects continued refinancing pressure to dilute Indian banks’ ability to pass on any interest rate cuts by the Reserve Bank of India (RBI) to borrowers. The transmission of monetary easing is more likely to be driven by a cut in the RBI’s cash reserve ratio (CRR) than a reduction in the repo rate, which will enable banks to offset the impact of a base rate reduction on earnings.
Ind-Ra estimates that the weighted average reduction in the base rate of Indian banks since early 2012 has been restricted to 40bps (as against 100bps of cuts in the repo rate). Some private sector banks, in a bid to maintain margins, have not cut their base rates at all. RBI reduced the CRR by 200bps during this period. The stunted transmission of monetary easing also stands in contrast to the government bond market, where the 10-year benchmark bond yield has come off by close to 100bps compared with end-April 2012.
Indian banks' structural shift to funding a large share of their assets with short-term deposits (50% of total deposits in March 2012) contributes to almost perennial refinancing pressure in the banking system. This is reflected in persistent tight liquidity conditions, and almost through the year flat-to-inverted yield curves. Banks are unable to realise benefits of interest rate cuts on their cost of funds due to their shift to a shorter tenor liability profile and the strong seasonal growth in quarters ending March, when they refinance a large share of their liabilities at elevated deposit rates.
Banks have reduced deposit rates recently, as loan demand traditionally tapers off after the post-March rush until June (loans grow less than 2% between April and June), as indicated by data for the last five years. However, deposit growth trends have also been similar; indicating that banks may accrue only a small share of their deposits at the lowered rates (below 3% of their total deposits till June). Therefore, in Ind-Ra’s view, lower deposit rates may not translate into a material reduction in the cost of funds in the near term. In fact, during periods of high growth, banks are forced to increase deposit rates to garner funds to fuel balance sheet expansion.
The average 40bps base rate reduction by banks has largely been facilitated by the 200bps cut in CRR. The agency’s calculations indicate that banks have been able to partly absorb the impact of reduced net interest margins (due to a reduction in yield following base rate cuts) because they have started earning interest income from the non-earning cash reserves that were freed up. Nevertheless, the contraction in margins is slightly detrimental to banks' stress tolerance capability.
(Source: Manager – Corporate Communications and Investor Relations, India Ratings & Research - A Fitch Group Company.)