INDIA BUSINESS WORLD - AUGUST 2006
THE MONTH THAT WAS...

LOAN RATES RISE BLOCKED BY GOVT

IN A sweeping display of authority, the government has told leading banks in the country not to rush through a hike in interest rate on all loans, including the fiercely growing home loans.

The country's largest bank, State Bank of India, associates of SBI and three nationalised banks — Punjab National Bank (PNB), Bank of Baroda (BoB) and Oriental Bank of Commerce (OBC) — have been directed to take prior authorisation from respective boards of directors before giving effect to a hike in prime lending rates (PLR).

Amitav Verma, joint secretary in finance ministry, has communicated this to the banks in a letter issued on Thursday.

PLR is the benchmark rate for banks, and a hike in PLR pushes up the interest rate on all loans — home, auto, personal as well as wholesale loans to corporates — that are linked to it. The move, which conjures memories of an administered interest rate regime that Indian banks have left long behind, comes close on the heels of Congressmen asking minister of state for finance (banking), Pawan Kumar Bansal, to stall interest rate revision on home loans.

Under present regulations, banks are empowered to freely price their loans and deposits. Except savings bank account and agricultural loans, there is no interest rate that is controlled either by the government or RBI. “This is micro management, and to-NADEEM tally uncalled for,” a senior banker said.

Interestingly, these days, proposals on interest rate revisions are not even placed before board of directors. Instead, the asset liability management committee, comprising senior officials of a bank, decides the timing and extent of rate hikes.

This week, several banks have hiked prime lending rates by 25-50 basis points. While this would cause an upward revision in rates of all loans, home loans, which have emerged as the fastest-growing asset for banks, have come under media glare. Making board approval must for them is a clear indication to go slow on the rate hike.

In the past, the finance ministry on several occasions had told banks not to raise rates at a level that would affect the flow of credit to productive sectors of the economy. However, banks have gone ahead with rate hikes; more so, with RBI raising the short-term benchmark rates twice in 45 days. The hike was a clear signal that the interest rate cycle has changed.

Between 2000 and 2004, interest rate fell by 500 bps. With the money market flooded with liquidity, cheaper loans triggered a retail loan boom. The tax break against housing loans further fuelled the loan spiral. After five years, the interest rate is taking a Uturn all over the world. While this could well be market reality, the dramatic move by the finance ministry is a testimony that higher interest on loans, just like the price of wheat and some essential items, have become political hot potato for Congress.