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Bank rates cut but little hope for lending rates to fall

CREDIT POLICY

The Reserve Bank of India cut the benchmark bank rate and eased liquidity aggressively in its mid-year monetary policy review on Monday, but said there were limits to domestic lending rates falling further.

"It needs to be recognised that in view of certain structural characteristics of our financial system, the scope for further softening in lending rates by banks and other financial intermediaries is limited," the RBI said in its review.

The RBI said the bank rate, used by commercial banks to price their loans, was lowered to 6.5 per cent from seven with immediate effect.

Banks' cash reserve ratio was slashed in two stages to 5.5 per cent from 7.5 per cent. It will be cut to 5.75 per cent from the two-weekly reporting period starting November 3 while the second cut takes effect from December 29.

The RBI said depositors in banks expect a reasonable nominal interest rate, in excess of the long-term rate of inflation, and recent reductions in deposit rates and return on small savings have caused widespread concern among depositors.

"This constrains the ability of banks to effect further reduction in their lending rates without affecting their deposit mobilisation and the growth of financial savings over the medium-term."

The non-interest operating expenses generally work out to 2.5 to 3.0 per cent of total assets, putting pressure on the required spread over cost of funds, the RBI said.

"Relatively high overhang of non-performing assets pushes up the lending rates further."

"There is a persistent and large volume of market borrowing requirements of the government giving an upward bias to the interest rate structure," it said.

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