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The above move will increase EMIs on Home, Consumer and other loans with RBI’s hawkish credit policy as I expect at least 0.5% up trend in the banks' lending rates. At the same time, in its Quarterly Review of Annual Policy Statement, RBI wiped out any hopes
of interest rate easing in the near future. Increase in CRR and Repo Rate would derail India Inc’s programme of borrowing for their industrial expansion and modification, as the cost of borrowing would go up. This will also make difficult to achieve GDP growth target which was earlier forecasted between 8.0-8.5% and revised by RBI in its review to 8%.

This move is double whammy for banks, it just means that a direct increase in fund cost and liquidity is being squeezed. Interest margins, loan growth and credit losses of the banks will be under severe pressure after this policy. RBI, in its post policy review, made it amply clear that banks would need to take the profitability pressure in their Income Statement. With the upward movement in CRR and Repo Rate, there is a dual negative impact on the banks' bottom line. Roughly at new level of CRR, bank has to keep additional around Rs. 2,60,000 Crore more with RBI, considering an average 9% yield, that means Rs. 23,400 crore is the reduction of profit in a year.

The negative impact on banks financial statements doesn’t end here; the bond values are also not taking the key rate changes with optimism. An increase in CRR and Repo Rate lead to macro deterioration with bond yields going up and bond value sliding. In the first quarter, bonds have managed to hold their bottom-lines, but I don’t think they can do the same now. I think that increase in CRR and Repo Rate will not only affect banks, their lendings, but also stock markets, manufacturing, agriculture and realty sectors, besides equally adversely affecting deposits. Reaction of the above can also be seen in the sharp negative movement in sensex on the day when the policy is announced.

By the increase in CRR and Repo Rates, the RBI seems to be telling the banks to increase lending rates. As banks are not paying attention to the RBI’s repeated appeals to moderate lending growth, which was a cause of concern for supervisor. Credit growth till July 4, on a year-on-year basis, was almost 26%, compared to 24.6% during the same period last year. This, coupled with lower deposit growth this year, has led to a rising credit deposit ratio. As abnormal growth in credit deposit ratio could mean that banks are over-stretching themselves to keep their income intact.

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Dr. Gourav Vallabh is at present Professor (Finance) at XLRI Jamshedpur.
He is a Certified Financial Risk Manager (GARP, USA), Chartered Accountant (ICAI, India), Company Secretary (ICSI, India), Ph.D. (UoR, India), M.Com., LL.B.
Currently, he is also associated with Govt. of Rajasthan in the capacity of Honorary Advisor to Ministry of Revenue.
Article posted on August 9, 2008.