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Banks impact of proposed bank rate cut

Mar 15, 2000

The proposed cut in bank rate by 1% ahead of the credit policy will have a many fold impact on the public sector banks. The proposed cut in the Cash Reserve Ratio (CRR) would be spread across two months as against a cut in bank rate in one tranche. One aim of the bank rate cut is to reduce the cost of short term funds. This would be achieved by reducing the bank rate as the refinance rate is linked to the bank rate. Hence any reduction in the bank rate will reduce the cost of overnight funds and hence make the market for short term securities more lucrative.

For the government securities that are held by the banks in their books, a reduction in rate would lead to an appreciation in the value of their securities. As banks are required to mark to market a portion of their securities at the end of the fiscal year this would lead to an increase in their book profits. The yield to maturity (YTM) on government securities currently stands at 10.67% for a ten year paper as compared to 12.05% for a ten year paper as the end of March'99. Hence even without a further cut the banks would gain substantially for their securities which are to be marked to market. Some banks feel that this reduction would lead to a distortion in yields and create an artificial appreciation in the securities held by banks.

The call rates are hovering around 8%-10% as the yield on short term paper has not fallen, a reduction in the bank rate will help reduce the rates in the short end of the market. This would lead to a gain for banks that operate in the short end of the market. Banks can subsequent to the bank rate cut reduce their borrowing costs.

As PSU Banks have very high staff cost and establishment expenses, they are not looking forward to a further reduction in bank rate. As the lending rate cut would be effective immediately, while deposits would have a time lag this burden of lower rates would impact their margins. As the establishment expenses and high wage costs of these banks is very high to sustain this these PSU banks are not in a position to reduce lending rates further. As PSU Banks are unable to absorb this in their costs which are already very high, the margins of these banks are likely to get affected. On the other hand the private sector banks are not saddled with high staff and administrative costs and hence they are less affected by the cut in interest rates.

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