Higher rates on small savings schemes are one of the reasons why banks are unable to lower interest rates on deposits when the central bank cuts interest rates.įor the new government, restoring India’s banking system to health is a priority. Hasmukh Adhia, former finance secretary and now the non-executive chairman of the Bank of Baroda, in a recent op-ed for Business Standard hinted at the need to bring down interest rates on small savings schemes for banks’ MCLR to come down. Higher interest rates on paper are poor consolation. It is partially evident in the current bad debt overhang that government-owned banks are still grappling with. Public sector banks are left with relatively lower-quality borrowers. Keeping all interest rates high pushes good-quality borrowers to the capital market or even to overseas markets. Lower interest rates can be used to attract better-quality borrowers. Sometimes, they may price it in such a way without recovering all their fixed costs from all of their assets. Banks should have the freedom to set their lending rates. However, it appears that the central bank has backtracked. With its economic reforms in 1991, India was supposed to have liberalized the financial sector first. The report notes that earlier banks used to lend below the prime lending rate and that the reason for abandoning that system was that it was not possible for RBI to ascertain if its policy actions were transmitted to the market. There is no incentive for competition nor for efficiency. MCLR is really administered pricing for the banking industry, similar to how refineries were compensated for processing crude oil. More bizarre than the owner interfering in operating decisions is the role that the regulator is playing with its elaborate prescriptions on interest rates that lenders charge. Lest readers have forgotten, the success of East Asian economies with their industrial policies is not that they chose and helped winners but importantly, they let the non-performers perish. The government will then have information on the efficient and inefficient enterprises that it owns and can make decisions on whom to nurture and whom to wither.
Indeed, even in the government-dominated banking sector as in India, it is possible to let banks set their interest rates.
Owners can demand profits but not set prices. Ideally, even owners should stay away from interfering with such decisions.
They are operating decisions to be taken by the managements of the institutions. Interest rates are the price set by profit-seeking commercial banks. It is difficult to understand the philosophy behind such an elaborately prescriptive regime for interest rates.
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