Reserve Bank of India (RBI) Governor Duvvuri Subbarao's situation is like that of a 'servant of two masters'. While a demanding government expects him to reduce interest rates to revive economic growth, banks - though not his master in the strict sense - want him to infuse liquidity into the system before they reduce borrowing costs for customers.
In its monetary policy review for the April-June quarter on Tuesday, the RBI governor partially met banks' expectations by slashing the statutory liquidity ratio (SLR ) to 23 per cent from 24 per cent. The SLR is the amount of deposits that banks must invest in liquid assets such as government bonds and gold.
The Indian banking system has one of the highest SLR requirements, and banks end up absorbing a lot of government paper. Clearly, the SLR reduction would help release additional funds into the banking system and allow banks to lend more. "Liquidity conditions play an important role in the transmission of monetary policy signals," the RBI says in its policy review.
In the past couple of months, banks were not very forthcoming in fully transmitting to their borrowers the RBI's earlier 50 basis-point cut in the repo rate. The central bank's reduction in its main lending rate, to 8.0 per cent from 8.5 per cent in April, was its first in three years.
But banks offered little reprieve to customers. Between March and June, state-run and foreign banks kept the base rate, the minimum lending rate, almost unchanged. While state-run banks maintained their base rates between 10.00 and 10.50 per cent, foreign banks kept their base rates in a range of 7.38-11.85 per cent. Only private-sector banks marginally cut their base rates, by 25 basis points to between 9.75 and 11.25 per cent.
Many experts blame high deposit rates for higher lending rates in the economy. Of late, many banks have been relying on high-cost bulk deposits. Also, banks have waged a rate war for savings deposits after the RBI lifted control over interest rates on such accounts last year. Today, some new-generation private banks offer 6-7 per cent on savings deposits, against the earlier cap of 4 per cent. Bankers say deposit rates must correct before lending rates come down. Still, the SLR cut would surely help in easing the cash shortage banks have been facing.