Exposed: Banks behind unfairly high cost of credit

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Bikky Khosla | 17 Oct, 2017
The Reserve Bank of India, in its fourth bi-monthly monetary policy review early this month, kept rates on hold, citing inflation concerns, a decision which according to India Inc, failed to take into account the unduly high interest rates that the industry is currently burdened with. It happens almost all the times. Whenever the central bank cuts the repo rate, the move is hailed and when it does not, an uproar follows. But a recent study report, interestingly prepared by an internal study group of RBI itself, points to a far more serious issue--commercial banks keep lending rates artificially high and this practice has turned out to be "deleterious" to retail and SME borrowers, even in an easy monetary cycle.

The report has found that banks, both public and private, purposefully deviate from the specified methodologies for calculating the base rate and the MCLR to either inflate the base rate or prevent the base rate from falling in line with the cost of funds. These "ad hoc adjustments" include inappropriate calculation of the cost of funds, no change in the base rate despite significant fall in the cost of deposits, sharp and out of tune increase in the return on net worth to offset the impact of reduction in the cost of deposits on the lending rate, and inclusion of new components in the base rate formula to adjust the rate to a desired level. These explosive revelations, though written in a mild, semi-academic tone, are contained in the 'Executive Summary' section of the report.

The findings also suggest that while banks are keen to keep most of the gains of RBI rate cuts with themselves, they pass on the policy rate hikes quickly to borrowers. Citing an example of this, the report mentions that pass-through to outstanding loans from the repo rate was around 60 percent during the tightening phase (July 2010 to March 2012), while it was less than 40 percent during the subsequent easing phase (April 2012 to June 2013). In other words, customers were deprived of 60 percent of the benefit, which according to an estimate, may amount to tens of thousands of crores, during the span of those 15 months only.

And banks have continued to do this probably for decades. In fact, the report itself admits that the issue has all along been a matter of concern to address which RBI has refined the interest rate setting methodology of banks from time to time. It introduced the PLR system in 1994, the BPLR system in 2003, the base rate system in July 2010, and the current MCLR system in 2016, but the experience, as the above statistics reveal, is still far from being satisfactory. So, the central bank's study group has now put forth a new set of recommendations, but only time will say if RBI will be able reverse the situation.

I invite your opinions. Wish you all a very happy Diwali.