Lending rates : India

Over the last one year, interest rate regime has changed from increasing to falling rate regime. Over the last one year, the Central Bank has used the two rate instruments it has to reduce interest rates and stimulate lending. The repo and the reverse repo rates have been decreased by 325 bps and 275 bps respectively oer the last 6 months. But the banks have not reduced the lending rates greatly, the spread between the deposits and the lending rates has only increased in the last quarter of FY 2008-09. The reasons for banks not being reduce the rates could be,

1. Reluctance to lend: 

The Banks, worried at increasing NPA's, are looking at reducing lending to sectors which they feel are really vulnerable to the economic slowdown. The are more willing to take hit on interst income rather than capital. With the current risk perception, Banks may be feeling that the interest rates should be high to cover the default costs. In the current scenario they seem to be comfortable parking funds with RBI. Nearly INR 100,000 Cr has been parked with the RBI under reverse repo window. The total investments in SLR was at 9.84 Lakh Crores as on Sep 26 2008 and 11.87 Lakh Crores as on Feb 27 2009. Another indication of the reluctance of bank lending has been the fall in the Credit Deposit ratio during the period from Sep 2008 till Feb 2009. The ratio has fallen by nearly 4%.

 RBI by reducing the reverse repo rates is specifically targeting this trend. With the current reduction the negative spread has increased to nearly 4.5% ( with respect to greater than 3 year deposit rate). 

2. High costs of funds:

Post the market fall in Jan 2008, the banking system has seen an increase in the deposits.The total Aggregate deposits with the banks in Feb 2009 was 38.51 Lakh Crores as against 31.85 Lakh Crores in Feb 2008. An increase of nearly  17%. Also an important fact to be noted is that during this period the deposit rates were very high. The high cost of funds is proving to be a major deterrent to the banks in lowering there lending rates.

Resolving these two issues is primary to increasing the credit flow at viable rates to the commercial sectors.