Be sure of what you want. You may get it.

Based on the current repo rate of 5.4 per cent, the impact on SBI’s profitability is compressed to 10 basis points (bps). Home loans offered by the bank now start at 8.1 per cent. However, we are in a declining repo trajectory.

Therefore, if the central bank announces another rate cut anywhere between 25 and 40 bps — in October or later — profitability or net interest margin (NIM) may take a huge knock. At 3 per cent in the June quarter, numbers have just about started firming up and looking better.”

Source: “Linking loans to external benchmark may delay SBI’s profit revival – Profitability may take further hit on policy rate cut of 25-40 bps [Link]

The Chinese proverb I have used in the header is a very profound one.

A template on how to merge

Tamal Bandyopadhyay not only writes interestingly but he also writes about good stuff being done. This piece is an example. He had written on how the Bank of Baroda went about merging Dena Bank and Vijaya Bank into itself. A good read.

It comes across as a good template for other PSU CEOs to follow. May be worthwhile to ask P.S. Jayakumar and the CEOs of the other two banks to hold workshops (half-a-day seminars?) for the entities being merged now (announced in late-August by the Finance Minister) on what they did and how they did it.

Just so that we know

The most popular Mudra loans, given to micro and small units, have three segments — Shishu (up to Rs 50,000), Kishore (between Rs 50,001 and Rs 5 lakh) and Tarun (beyond Rs 5 lakh and up to Rs 10 lakh).

As on March 2019, 16.2 per cent of the Shishu loans have turned bad (for Bank of Maharashtra, it’s 48 per cent and for BoI and Punjab National Bank and a couple of others, at least 25 per cent); the bad loans in the Kishore scheme are 13.22 per cent (four banks, including SBI, have more than 20 per cent bad loans) and Tarun scheme, 9.61 per cent.

We are yet to know the state of affairs at the 59-minute loans (Rs 1 lakh to Rs 5 crore), as loans disbursed on the fast lane are not a year old as yet. [Link]

Incentivising malpractice

The mind-bending complexities of the new financial technology combined with the modern practice of incentive payments that reward employees for particular deals practically invites malpractice, whatever the pious institutional statements about the priority placed on client relationships and an ethical culture. In fact, rewards for successful proprietary transactions, inherently speculative and often in conflict with client interests, will tend eventually to color the overall atmosphere and the reward systems in banks, even beyond the trading rooms.

Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (p. 216). Public Affairs. Kindle Edition.

The emphasis was mine and that is the key part of that comment.

Wake up, gentlemen. I can only say that your response is inadequate. I wish that somebody would give me some shred of neutral evidence about the relationship between financial innovation recently and the growth of the economy, just one shred of information.”

Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (pp. 216-217). Public Affairs. Kindle Edition.

… concerns about regulatory complexity are common and not limited to financial regulation. Pictures of the thousands and thousands of pages of federal regulation are grist for election campaign mills. I cringe, like others. But then I also cringe a bit when I receive, each year, the eighty or so pages explaining precisely my rights and the policy limitations in my “simple” household insurance policy.

Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (p. 218). Public Affairs. Kindle Edition.

India’s banking trilemma

Notwithstanding the controversies that dogged his tenure at the Reserve Bank of India as its Governor, Urjit Patel has made an important and interesting presentation at the Stanford-India conference in June on India’s banking sector problems. As Urjit Patel frames it, the ‘Impossible Trinity’ of Indian banking is this: Dominance of government-owned banks in the banking sector, independent regulation and adherence to public debt-GDP targets. India can have only two of the three.

But, in fact, political economy considerations dictate that India follows only the first of the three. In the presence of the first, the other two are impossible, except in terms of appearances.

India’s banking crisis is a huge opportunity missed.

His presentation is worth going through and storing for reference. Lots of good tables and charts.

An institution learns humility

Whoever chose this header for the story – whether the journalist herself or her Editor – he or she deserves praise for doing so. The header of the article is “RBI’s 12 February circular makes a comeback with a dash of humility”. Nice.

All institutions need to go through the cycle of competence – confidence – overconfidence-overreach-setback-humility. Probably, RBI had to have its moment. Its circular of 18th February 2018 was an over-reach. I went through the circular (‘Prudential framework for resolution of stressed assets’, June 7, 2019) It does not relax the credit discipline and yet it provides time for resolution before the non-performing debt goes before the bankruptcy court.

Monetary policy transmission in India

In its monetary policy meeting last week, the Reserve Bank of India’s Monetary Policy Committee cut the policy rate – the repo rate – by 25 basis points. This is its third rate cut since December 2018 and it was unanimous. The Committee also unanimously decided to move to an ‘accommodative’ stance indicating further easing down the road. So far, so good.

Transmission from RBI policy rate to the lending rates fo banks remains the big challenge in India. See this article in ‘Business Line’, for example. Some banks have even increased their lending rate since the last RBI policy rate cut!

Everyone – including my friend Gulzar Natarajan – points out that Indian banks have a much higher share of their liabilities in bank deposits. These deposits are fixed in nature. Therefore, interest rates on them are payable at a fixed rate regardless of the movements in the policy rate. Since they cannot come down with cuts in the policy rate, the lending rates too cannot be lowered. Ergo, there is no transmission.

Gulzar even shared a chart with me that showed that Indian banks’ deposits as a % of overall liabilities is higher compared to other developing nations.

But, the truth is that Current and Savings Accounts (CASA) are more than 40% of overall deposits. 41.3% to be precise. The last data point available – in a easy to retrieve manner, that is – is from February 2019. See here.

Current accounts pay no interest and the interest payable on savings accounts is 4% – at the lowest balance between the 11th and the end of the month. That is as low as one can get, in terms of savings account balances. In the first ten days, the balance could be higher due to salary deposits. That is why they are excluded!

Therefore, the argument is somewhat unconvincing. Not untrue but not the total explanation.

The explanation lies in lack of competition with the central bank prescribing a floor for lending rates via its formulaic Marginal Cost of Deposits based Lending Rate (MCLR). I wrote about it in my MINT column last Tuesday.

If one went through the RBI Internal Working Group Report on the MCLR and the previous base rate, published in October 2017, one would realise that these are not MCLR (i.e., not marginal) but that they are also binding floors for lending rates.

Note a key sentence in the report:

One bank included a negative spread under business strategy due to market competition, which was in contravention to regulatory guidelines. (PAGE 47)

Indeed, that should be the case. Banks should have the freedom to take the basic of decisions for a commercial entity – the pricing decision. But, they do not.

India needs genuine competition in lending rates between banks. Neither the owner nor the regulator must intervene. It will also enable the owners to figure out which of them are worthy of further capital infusion, growth and which of them deserve to be merged, consolidated or weeded out.

Of course, the second thing is the Small Savings Interest Rate. Check out the table in page 26 of the said report (Table II.8).

Interest rates offered on bank deposits are lower than that of the interest rates on small savings and these interest incomes are tax-free too. The Government-announced interest rates on these Small Savings Schemes are higher than that of the rates that would be offered if the government sticks to the formula that it promised – linking the interest rate to the 10-year Government bond yield. It has not. On top of it, there are tax benefits.

That is the second (or, even the first) biggest hindrance to transmission. That is why I felt that the usually meticulous Indira Rajaraman quite did not get it right in her column on the topic of transmission. She is right with her conclusion, of course. The multiple strands that link the funding of government budgets (of the States and the Union) to the National Small Savings Fund (NSSF) need to be broken. She is right on that one.

But, more than that, the idea of offering a higher interest rate on a product that is even safer than a bank deposit and with tax benefits is a sure-fire killer of the banking system profitability and of transmission of monetary policy.

Some politically unpopular decisions need to be taken. They will be unpopular in the short-term. But, a government with its back to the wall on the banking system and with such low actual economic growth (more on that in a separate blog post) has to take some decisions and face up to the tradeoffs. There are no costless choices here.

Surjit Bhalla had got this one right. One of the most important decisions ever taken by a FM was taken by Yashwant Sinha when he lowered the interest rate on Small Savings Deposits. That did play a big role – among many other things – in India’s post-2002 economic boom.

Surjit Bhalla had got this one right. One of the most important decisions ever taken by a FM was taken by Yashwant Sinha when he lowered the interest rate on Small Savings Deposits. That did play a big role – among many other things – in India’s post-2002 economic boom.