Tightrope walk for banks

Erosion in both lending and deposit rates of banks has been on for many months mainly because of poor demands for funds from the private sector. The average interest rate spread came down to below 5.0 per cent in March last after a long time and the gap between the lending and deposit rates has been narrowing further since then.  
However, many tend to consider the prevailing lending rates offered by the banks high, when compared to that in other developed and emerging markets. Local corporate houses have been borrowing foreign funds at 4.0 to 4.50 per cent plus LIBOR (London Inter-Bank Offered Rates).  The average borrowing rates for them, thus, would not be more than 5.5 per cent, which is less than half of the average lending rate of the local banks.
In such a depressed demand for funds, genuine large borrowers with good track record are reportedly out to cash in on the situation. They have been pressing the banks hard to lend funds at lower rates and the banks now floating in surplus liquidity have no other option but to concede to such demands.
In fact there was a time when there were, literally, beelines, formed by the intending borrowers, before the banks to take funds even at rates hovering between 15 and 19 per cent. But now the rates as low as 11 per cent banks are failing to attract the borrowers in sufficient numbers.
 At least two major factors have contributed to the emergence of the precarious situation in which the banks now are. The depressed investment climate is one and the second one--- extra caution exercised in lending--- is the doing of the bankers themselves.
The banks can do little if the investment demand remains low because of political reasons or infrastructural bottlenecks. These are the issues that need to be addressed by the government.
However, lending rates much lower than the prevailing ones could have raised the demand for bank funds, contributing to the creation of a better investment situation in the country.
But the banks are not in position to lower their lending rates much because of a few practical reasons. The average interest rate offered by the banks to depositors is now slightly over 6.5 per cent. Adjusted with the current rate of inflation, the real rate of return on the deposit turns out to be zero. And the return tends to be in the negative in the case of savings deposits with banks.
If the banks lower their rates on deposits further to cut their cost of funds, depositors would take out their funds in large volume and invest in the government savings instruments that offer interest rates above 11 per cent.
These days, savers who cannot afford to keep their funds in savings instruments for three to five years are usually availing the short-term FDR facilities of the banks.  
Under the circumstances, it would be pretty difficult for the banks to lower further their deposit rates given the prevailing rate of inflation.
The second barrier to lowering the lending rates remains to be the banks' profitability if seen in the context of the current volume of their classified loans.
The volume of non-performing loans (NPLs) of the banks, according to the central bank statistics, now stands over 10 per cent of the total outstanding volume. The actual size of NPL would be even bigger if the banks are forced to include in their financials the window-dressed loan volume. The banks, the private ones in particular, hide facts about NPL, primarily, to avoid actual provisioning. Many banks would be in the red if the entire volume of soured loans are included in their financials and provisioned as per requirements.   
Undeniably, the regulatory supervision and monitoring in the country's banking sector has been strengthened in recent years. But still there are weaknesses and flaws in some areas.
The central bank is legally barred from taking actions in some affairs of the state-owned banks. It cannot be blamed for administrative failures on the part of the management of those banks.
The central bank's monitoring in some areas of operation of the private banks is very stringent. But as far as the classification of loans and their rescheduling are concerned, it appears to be a bit lenient at times.
For instance, at the fag end of the last year, the central bank, for reasons best known to it, turned out to be unusually generous. It, on December 23, 2013, had issued a directive relaxing the loan rescheduling facility for six months until June 30, 2014.  
Banks were allowed to reschedule loans by fixing their down payment and time-limit for repayment on the basis of 'customer-banker' relationship.
The banks were given the 'breathing space' in view of the loss of business due to unprecedented political trouble centring around the national polls in the latter half of 2013.
The revised rescheduling policy had offered the banks the opportunity to window-dress their respective NPLs and present relatively healthy financials for the year 2013.
The size of the NPL was 13 per cent in September, 2013. It had come down to less than 9.0 per cent following the relaxation of the loan rescheduling rules.
Interestingly, according to banking sector insiders, the relaxed loan rescheduling facility is still being offered by a few banks and the central bank overlooks those. The reasons are best known to both the banks concerned and the central bank. But it is not at all a healthy practice. It needs to be avoided.
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