Indian PSU banks turn contrarian by cutting interest rates

Some large public sector banks have begun cutting rates of fixed deposits and loans, despite no change in the Reserve Bank of India’s stance towards interest rates. The RBI has held that inflation is an overriding concern, and holding interest rates high may affect growth but will help in curbing inflation. So, what explains the action of public sector banks?

Cutting fixed deposit rates will lower their costs of raising incremental funds, but there is a risk of driving away retail money to other avenues. Still, it may help banks lower loan rates without taking a hit on margins. One explanation could be that banks had headroom to lower interest rates, since there is more liquidity in the banking system now.

But could the finance ministry be behind this change in the stance of PSUs? Private sector banks have not jumped on to the rate cut bandwagon, which may indicate that the environment does not really support such a strategy.
The finance ministry saw a change at the helm in mid-July, when P Chidambaram stepped in after his predecessor, Pranab Mukherjee, became the President of India. Chidambaram is known to have a pro-business stance, favouring low interest rates, and in his previous stints as the finance minister, has always pressed for lower interest rates, even when the RBI has had a different view.

Not surprisingly, when the finance minister met heads of PSU banks on August 18, he asked them to cut consumer loan rates. While the minister can officially only urge, and not order, the PSU bank chairmen to reduce interest rates, they are known to fall over each other to please the FM.

But cutting loan rates will mean a big hit on margins and hence liability rates will have to decline as well. The recent past has seen a number of banks take action. The State Bank of India, the largest public sector bank, reduced interest rates on fixed deposits with effect from September 7, by at least 50 basis points in most maturities, and by 1 percentage point in one category (241 days to less than 1 year). 1 per cent equals a hundred basis points.

Earlier, in August, even before the FM’s meeting, SBI had reduced home loan rates by 25 basis points and auto loan rates by 40 basis points. More banks in the public sector space are following suit. Oriental Bank of Commerce has announced a 25 basis point reduction in home loan rates in the 15-25 year tenure category, and a 40 basis point cut in car/vehicle loans. Punjab National Bank too has cut home loan rates by 25 basis points and car loans by 50 basis points.

What is the finance ministry’s larger objective in doing this, despite the risk of hurting the banks’ financials? A cut in interest rates on consumer loans may further the government’s desire to prop up growth, by reviving consumption.

The government appears to have realised it does not have the ability to undertake serious reforms, which can encourage the RBI to lower rates, by tackling supply-side issues or by hiking prices of subsidised fuels. Automobiles and real estate are two sectors whose growth has a multiplier effect on the rest of the economy.

Cutting rates is one way of showing empathy with the voting population, with no direct cost to it, as it only has to influence public sector banks. Soon, private sector banks too may have to join the rate-cut bandwagon, especially if SBI follows up its latest cut in deposit rates with another round of lending rate cuts.

So, what’s the harm if the government bends the system a bit? The fact is by doing this the government is making the RBI’s task difficult. Inflation is still ruling uncomfortably high – a fact that should concern the government too. By giving a fillip to growth, the government may please equity markets, but inflation may remain stubbornly high.

The resulting situation is not going to help anybody, including savers. Lowering interest rates on FDs when inflation is not going down is one more slap on their face, even as the government continues to play the protect-the-producer role. Strange that the wrath of a billion consumers does not invoke as much concern as that of an influential minority—of disgruntled industrialists and farmers.

What about the interests of minority investors in public sector banks? They can’t complain, they should have known what they were getting into, when they chose public over private sector banks. The government has made no secret of the fact that it treats public sector companies, listed or not, as an integral part of government policy.

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