Future interest rates

Need for speedy increase in loan rates | Future interest rates

Wednesday, May 11th, 2011

Banks usually take time to pass or not pass on a part of the quantum of rate hikes to consumers but this time round over 20 banks have already passed on the entire key rate hiked by the Reserve Bank of India (50 bps in lending rates). This is post the sharpening of monetary policy by the central bank on 3^rd May.

Apart from raising its policy rate, RBI also raised the rate of interest that banks pay to savings bank account holders by 50 bps as well. This has pushed up the cost of savings deposits immediately. When they raise rates on their term deposits, it takes time to feel the impact as only the new deposits earn higher rates while the existing deposits continue to be priced at old rates till they mature.

The combination of all three—a hike in policy rate, savings rate as well as higher provision of bad assets—has made money more expensive and banks have no choice but to raise loan rates instantly. Experts believe that this rate hike will definitely affect loan growth. Existing borrowers will also find it difficult to service higher interest cost.

Statistic: The vicious circle of higher cost of funds for banks or in other words why the interest rate will increase further:

The Indian banking industry’s loan book grew 21.4% in fiscal 2011, higher than RBI’s projection of 20% growth. In 2012, RBI wants banks’ credit growth to be 19%. A drop in credit growth will bring down banks’ interest income and, on top of that, if their bad assets grow, they will have to set aside more money to provide for them. This will affect their profitability unless they find ways to bring down their cost of operation and become extra-sensitive to the quality of assets. This also means a close monitoring of all loan accounts and a very strict appraisal of new loan proposals.

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