SBI makes a smart move

Should banks be linking their lending rates to an external benchmark? The Reserve Bank of India (RBI) seems to be having second thoughts on the subject. That has not stopped State Bank of India (SBI) from making its first move in this respect.

SBI has linked its rate on saving bank deposits and its rates for cash credit (CC) and overdraft (OD) to the repo rate. In both cases, this will be applicable to accounts of over Rs 1 lakh. The saving bank deposit rate has been pegged at 2.75 percentage points below the repo rate (currently 6.25 per cent), that is, 3.50 per cent. The floor rate for CC and OD will be 2.25 percentage points above the repo rate, that is, 8.50 per cent.

Saving bank deposits account for 40 per cent of SBI’s deposits, and 80 per cent of these deposits are valued at over Rs 1 lakh. Thus, 32 per cent of SBI’s deposits would be market linked. Corporate advances at SBI are 40 per cent of all advances. Even if we assume that 50 per cent of these advances are in the form of CC and OD, the latter would account for just 20 per cent of advances. In a declining interest rate regime, such as the one we are in, SBI’s net interest margin would be favourably impacted by the move.

SBI’s lending rates for other products (including housing loans) would be affected very modestly. These rates will be impacted through a reduction in the marginal cost of funds based lending rate (MCLR). The SBI move does not impact 68 per cent of all deposits and deposits are not the only sources of funds for banks. A 25 basis points (bp) change in the repo rate may translate into a change in the MCLR of about five or six bp. Complete transmission of the repo rate is possible only when banks can offer floating rates on term deposits. Indian depositors have shown no appetite for such a product.

Will other banks seek to emulate SBI? Well, some public sector banks (PSBs) may but private banks are unlikely to. For depositors, saving bank accounts at PSBs are about safety. These accounts are intended for transactions and not for returns. Not so the saving bank accounts at private banks. Unless the returns are attractive (relative to other investment opportunities), depositors would not want to risk their deposits with private banks. Besides, private banks need high deposit growth in order to sustain their higher rate of credit growth relative to PSBs in recent years. They are unlikely to want to drop interest rates on saving bank accounts.

SBI’s offerings of CC and OD will now become very competitive. The move is smart because it will boost, not just the net interest margin, but SBI’s market share in these products. If you are the market leader, you must act like one. SBI’s move is a welcome sign that the consolidated giant is willing to do so.

Large exposure limit for banks

One other development in banking is worthy of note. The RBI is going ahead with its effort to limit concentration risk at banks. Banks and corporates had expressed their reservations after the RBI had made its Large Exposure Framework available for public comments in August 2016.
Effective April 1, 2019, banks’ exposure to a single borrower will be capped at 20 per cent of tier 1 capital (present limit: 20 per cent of total capital). Banks’ exposure to a group will be 25 per cent of tier 1 capital (present limit: 40 per cent of total capital).

The RBI’s move bodes well for risk management at banks. The single biggest cause of higher non-performing assets at PSBs is neither corruption nor lack of competence in assessing credit risk, as is widely supposed.  

Corruption is a constant in the system. It cannot explain the improvement in NPAs in the period 2004-08 or the huge build-up in non-performing assets (NPAs) consequent to 2013-14. As for skills in appraising credit risk, in many of the large NPAs in the system today, PSBs were members of a consortium that included private as well as foreign banks. The latter cannot be said to have shown superior expertise.

No, the fundamental failure of PSBs lay in managing concentration risk. PSBs got exposed to infrastructure and related areas to a greater extent than private banks. Private banks had a larger exposure to retail credit and, to that extent, were protected from the failures in the corporate world. The risk management committees of the boards of PSBs should have ensured that they stayed well within the RBI’s exposure limits. They failed to do so.

The RBI has, no doubt, concluded that managing concentration risk is too important to be left entirely to banks. Its initiative could be hugely disruptive in the medium term. Banks will be forced to look for new business. Large corporates will have to source a larger portion of their funds from outside the banking system.  Banks and corporates have their work cut out for them, but the RBI’s initiative promises to make the banking system safer.
The writer  is a professor at IIM Ahmedabad.

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