Banks risk losing market share for short-term margins: Rajan

Reserve Bank of India Governor Raghuram Rajan on Tuesday nudged banks again to do more on lending rate cuts, pointing out that one percentage point deposit rate cuts in recent times have been wider than those for credit.

With other fund-raising alternatives for companies like the commercial papers and certificate of deposits reflecting the RBI's rate cuts -- it has cut the repo rate by a cumulative 0.75 per cent this year, Rajan said banks will eventually be forced to act to hold on to market share.

The central bank wants the lending rates to be determined by the market, which will be primarily depend on marginal cost of funds, he said.

Currently, banks fix lending rates based on the average cost of funds which is pegged to deposit costs.

"If I look at the bank fixed deposits, because that is the only thing I can invest in, the rate has come down by one percentage point to 8 per cent.

“Over time, this has to be passed through to the lending side," Rajan told reporters at the customary post-policy press conference after he cut the repo rate by a 25 bps to 7.25 per cent.      

Rajan said RBI is awaiting feedback from bankers on a proposed revision in framework on base rate computation, under which it plans to shift to the marginal cost of funds system.

The move, announced in the first bi-monthly policy statement on April 7 and which was frowned upon by bankers, is a stop-gap arrangement and RBI would ideally want the system to migrate to a market-determined benchmark rate of lending in the medium term, the Governor said.

Base rate is the minimum rate of lending for banks and was adopted in July 2010 to make the rates more transparent.

After Rajan's hard talk in April, where he termed the bank's insistence for holding on to high rates as ‘nonsensical’, banks have cut their lending rates between 10 and 25 basis points.

At Tuesday's conference, he pointed out that the CP and CD markets are reacting in tandem with RBI's moves and companies are going to those markets to borrow.

"Firms are going directly to it, thereby disintermediating banks, which is putting pressure on the banks to cut their rate," he said, adding, bankers have "to make a choice between holding on to higher margins today and maintaining their market share tomorrows."

Rajan on Tuesday cut the repo rate at which the central bank lends to the system by 0.25 per cent to 7.25 per cent, to boost the sagging investments.

Ideally, it wants a smoother transmission of these actions in the real market.