Arghhh, Mr Jaitley it's still not about cutting interest rates

Jun 9, 2015

- By Vivek Kaul

Vivek Kaul
The finance minister Arun Jaitley is at it again. A recent report in the Business Standard suggests that Jaitley is scheduled to meet public sector banking chiefs on this Friday i.e. June 12, 2015, and ask them why they haven't cut interest rates in line with the Reserve Bank of India (RBI) cutting the repo rate.

The RBI has cut the repo rate by 75 basis points (one basis point is one hundredth of a percentage) to 7.25% since the beginning of this year. Repo rate is the rate at which RBI lends to banks. In response banks have cut their lending rates by only 30 basis points.

The finance minister wants to know why banks have not matched the RBI rate cut when it comes to their lending rates even though they have cut their deposit rates by close to 100 basis points over the last one year.

The finance minister believes that at a lower interest rate people and companies will borrow more, and banks will lend more. But as I have often said in the past this is a very simplistic assumption to make.

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First and foremost a cut in the repo rate does not bring down the legacy borrowing costs of banks. Hence, lending rates cannot always fall at the same speed as the repo rate. Further, data from the RBI shows that as on May 15, 2015, nearly 29.9% of aggregate deposits of banks were invested in government securities. This when the statutory liquidity ratio or the proportion of deposits that should be invested in government securities, stands at 21.5%.

So what does this mean? Banks have way too much investment in government securities. In fact, as on May 15, 2015, the total aggregate deposits of banks stood at Rs 87,39,610 crore. Of this amount around 29.9% or Rs 26,14,770 crore is invested in government securities.

As things currently stand, banks investing Rs 18,79,016 crore in government securities would have been suffice to meet the regulatory requirement of 21.5%. What this means that banks have invested Rs 7,35,754 crore more than what is required in government securities.

Why is that the case? The answer could be lazy banking or the lack of decent loan giving opportunities going around. Clarity on this front can only come from banks doing the necessary explaining.

There are other things that Jaitley needs to consider as well. The bad loans or gross non-performing assets of banks have been going up. As on March 31, 2014, they had stood at 3.9% of their total advances. By March 31, 2015, the number had shot up to 4.3% of the total advances.

The situation is worse in case of public sector banks. As on March 31, 2015, the stressed asset ratio of public sector banks stood at 13.2%. The stressed assets ratio of public sector banks as on March 31, 2014, was at 11.7%. The stressed asset ratio of the overall banking system was at 10.9% as on March 31, 2015 and 9.8% as on March 31, 2014.

The stressed asset ratio is the sum of gross non performing assets (or bad loans) plus restructured loans divided by the total assets held by the Indian banking system. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan by increasing the tenure of the loan or lowering the interest rate. Hence, a stressed assets ratio of 13.2% essentially means that for every Rs 100 given out as a loan, Rs 13.2 has either been defaulted on or has been restructured.

What this clearly tells us is that the situation of the public sector banks has gone from bad to worse, over the last one year. In this situation it is hardly surprising that the banks have cut their fixed deposit rates but haven't cut their lending rates by a similar amount.

With increased bad loans, they need to earn a higher margin on their good loans, to maintain or increase the level of profits. This scenario has arisen primarily because many corporates have been unable to repay the loans they had taken on.

Banks have not been able to recover these loans. A newsreport in The Economic Times yesterday pointed out that the RBI is mulling a new rule that will give lenders a 51% equity control in a company, which fails to repay a loan even after its loan conditions have been restructured. Whether this happens remains to be seen. Further, many companies which failed to repay loans belong to crony capitalists who continue to be close to politicians.

Also, it needs to be pointed out that the corporate profits as a share of the gross domestic product is at 4.3% of the GDP, which is the lowest since 2004-2005. (I would like to thank Anindya Banerjee who works with Kotak Securities for bringing this to my notice).

What this tells us is that corporates as a whole are still not earning enough to be able to repay any fresh bank loans that they may take on. In this scenario insisting that the banks cut interest rates and lend is not the most suitable suggestion to make.

The Economic Survey released earlier this year had a very interesting table, which I have reproduced here.

Top Reasons for stalling across ownership
Source : CMIE

What the table clearly shows is that a lack of funds is not one of the main reasons for the 585 stalled projects in the private sector. In case of the 161 stalled government projects, the lack of funds is the third major reason. Hence, there are other reasons which the government needs to tackle, in order to get these projects going again. Lack of finance is clearly not a main reason.

Further, the high interest rates on post office savings schemes put a floor on the level to which banks can cut their fixed deposit rates and in the process their lending rates. This is something that the public sector banks can do nothing about.

To conclude, what all these reasons clearly suggest is that Arun Jaitley and this country would be better off if we got rid our fixation for lower interest rates being a solution to reigniting economic growth. There are other bigger things that need to be sorted out first.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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7 Responses to "Arghhh, Mr Jaitley it's still not about cutting interest rates"


Jun 11, 2015

Vivek, Interesting analysis, as always.

However, I have an observation on the following section "Also, it needs to be pointed out that the corporate profits as a share of the gross domestic product is at 4.3% of the GDP, which is the lowest since 2004-2005."

What does this statement convey? Share of post-tax corporate profits in the overall GDP? If so, then this number may not be very low. Firstly, the overall GDP includes products and services from ALL sectors, not just the corporate sector. Secondly, the 4.3% profit is the money the corporates made AFTER paying the banks' interest charges and income tax.

Lowering interest rates has been a traditional stimulus, but I agree with you that "ease of doing business" would probably have a higher effect on new capital investments than interest rate cuts.


Ramesh Doshi.

Jun 10, 2015

Dear Mr.Kaul, -A brillient analysis. However Mr.Jaitely can not be blamed equally so Narendra Modi Govt. This Govt. is trying its best to revive the economy almost made Bankrupt by UPA Ii.Perhaps Governor Rajan appears to be too theoretical in his approach.YOU CANNOT BLAME THE GOVT for present economic maladies & he has to work in tandem with Govt & this is a Joint Task. Our approach need to be Constructive by offering Viable Solutions.We need to suggest what Mr.Jaitely needs to do more.Public Sector Banks have been made free from Political Interference which is the main cause for their dismal working resulting in Higher NPA'S.We must Congradulate Govt.for this.A pat at the back is the need of the day.


R Tayal

Jun 9, 2015

Dear Vivek,

I have ben following you on The Daily Reckoning for the last several months and have come to develop a healthy respect for your jargon free economic analysis which any reasonable educated person can follow. However in the present case, I believe you too are guilty of the same simplistic conclusions you accuse Jaitley of. Surely attractive interest rates alone don't spur investment, businesses also need to see a market for their goods & services. Certainly Jaitley is not expecting lower interest rates to be the panacea for spurring investment in each & every sector, but it would certainly help in bringing in some investments where the ROI becomes attractive with lower interest. Further your linking stalled projects with interest rates has little correlation. Obviously stalled projects were viable at the prevailing interest rates when these projects were conceived. The stalling has naturally to do with other factors which are well & truly captured in the economic survey excerpt you have reproduced.


Ravindra Mehta

Jun 9, 2015

I am in full agreement with Mr. Kaul. Let the govt leave the banks alone in deciding their business strategy as well as allow them to take independent informed decisions on loan portfolio. The govt should concentrate more on creating a conducive environment for an entrepreneur to take risk in starting a venture, putting in place clearly visible policy regime.

Simultaneously the govt should impress upon the bank managements to attract and retain talent in the field of credit appraisal and monitoring. It is the need of hour to ensure no interference in decision making process and the meritocracy is promoted.


satish dabholkar

Jun 9, 2015

If you go on writing so many articles,it is not going to make improvement in the banking sector.There are various reasons as follows-
1)The number of staff in the public sector banks are not increased in proportion to the increase in business mix and number of branches.Pl get the details from finance ministry the business mix as on 2004 and as on 2014.It may be argued that because of fast means of computerization and inter connectivity of the branches is improved.But there is no system were banks can arrive at true figure of number of staff required.
Naturally no attention is given about recovery of bad accounts.Easy way is followed of write off and this has affected sentiment of borrowers who repay the loan regularly.Previous government also came with schemes of write off of loan amounts of small farmers/borrowers resulting an atmosphere is created in all over India that by not repaying any loan amount"KUTCH NAHI HOTA"If anything is done on this front, public sector bank's improvement is not possible.



Jun 9, 2015

I read your column regularly and I like it. The tone of this column seems to be biased towards the banks who probably have given loans without checking credit history of individuals/polititians/corporates. We all know that this data is available to RBI as well as Jaitley - so the intent of Mr Jaitley would be to understand why the NPAs are growing and what actions Banks are taking to sort this out. Why should an individual customer suffer just because Banks couldn't recover bad loans? I think it is right to question the Banks so that they won't continue doing things which they are doing. Are you saying Banks lowered the rates last time just because RBI governor asked them to do so? I am sure he knows what goes on Indian Banking System specially the PSUs.
Anyways thanks for very informative article.



Jun 9, 2015

I agree reduction of interest is not only solution to revive economy, till people do not develop faith that their project is viable no body will take risk and till demand pattern changes any increase of production is no solution.Indian economy develop on sme that is now most neglected area and to get money from bank for them is most can only wish that things will improve,

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