Bank deposit rates in India are climbing exactly at a time they should be moderating so as to allow lower cost of funds to set the context for lower lending rates. ICICI’s housing finance unit offering 11.15% for deposits of up to 30 months is the latest example. True, deposit rates started increasing from 2006-07 when (for one- to three-year maturities) they were in the range of 7.5% to 9%, a break from the 2002-03 to 2005-06 period, when rates were as low as 4.25% and never hit 7%. But 2002-03 to 2005-06 was also the time when bank lending rates were low. And, similarly, the upward trend in deposit rates from 2006-07 coincided with the policy-induced hike in lending rates. CRR and repo were increased repeatedly. However, over the last month-and-a-half or so, these policy rates have been cut and there are clear signals that more cuts will take place. But this has also been the time that banks, public or private, have increased deposit rates. The period between September 19 and October 24 this year saw the band of deposit rates of more than one year maturity change from 8-9.5% to 8.75-10.5%. Since then, the 11%-mark has been breached. You don’t need to be a banker to know that if deposit rates are around 10% to 11%, even prime lending rates simply can’t budge from the 13-14% band. Indeed, the September 19-October 24 period that saw the jump in the deposit rate band also saw the prime lending rate band jump from 12.75-13.25% to 13.75-14%. The small cuts in lending rates by public sector banks of late don’t buck this trend, especially since banks can cut PLR and still increase lending rates for most borrowers.
Banks are probably in part buying insurance against future liquidity scare by attracting more deposits with higher rates. The best way to counter that, as these columns have argued, is for pro-active cuts in CRR. Overcompensate with liquidity and then ask banks why they are still increasing deposit rates. Banks, whether they admit it or not, are also enjoying high income from high lending rates. But they must reckon with the higher risk of default that comes with a high interest rate regime in economic hard times. Banks’ argument against this is that it is precisely because economic prospects are not good that they are afraid of mispricing risk by lowering lending rates ‘too much’. Is this an unsolvable chicken and egg problem? No. The government can change the game by intelligently directing its spending commitments. In many cases this would mean spening money already committed, as these columns argued yesterday. Banks need to cut lending rates and therefore deposit rates. The government must give them the signals.