Lending rates to rise as bank funding costs jump

With liquidity in the banking system tightening, lenders are set to further raise interest rates in the coming months.

Corporate credit is picking up, funding costs are rising, deposit rates climbing and cash set to get scarce further ahead of polls in several states and general elections next year are indications of impending hike in lending rates, say experts.

ICICI Bank on Wednesday announced a 0.10% to 0.25% rise in deposit rates, which is likely to translate into higher lending rates in the coming days.

The banking system currently has a liquidity shortage of Rs 80,000 crore. Reserve Bank of India (RBI) has been easing the liquidity through the open market operations (OMOs), wherein it buys government bonds from banks and releases money into the system. RBI is expected to conduct an OMO of Rs 40,000 crore this month.

ICICI Bank said that the liquidity in the banking system is extremely tight.

"So it is fair to assume that in the second half of the current financial year the funding cost will go up for all the banks, including us," its chief financial officer Rakesh Jha told analysts in an earnings concall.

Banks are poised to raise lending rates irrespective of whether RBI increases the rate at which it lends to banks (considered to be the signalling rate in the system) or not in the next credit policy on December 5.

The migration to higher lending rates is a natural consequence of a high demand for loans and slow deposit growth at just 9% over the previous year.

However, some lenders such as State Bank of India (SBI) say they are sitting on excess liquidity and there is no immediate need to hike deposit rates. "However, we will take a call depending on the quantum of credit growth, the competition in the market and the liquidity position in the bank," Prashant Kumar, chief financial officer, SBI, said.

The rate on Certificate of Deposit, instruments that banks use to raise deposits from the money market has gone up by close to 0.50% in the October over the rates in September; in comparison the retail term deposits have moved up only by 0.25% to 0.30% in the last six months. So bankers say that retail deposit rates will rise as the money market rates are already rising.

"We will be focused on passing on the increase in funding cost to the lending side, but we will have to just see how that plays out. So I would not want to say that margins have bottomed out for the system per se, but our focus will definitely be to ensure that we pass on all the increase that we see onto the lending side," Jha said.

ICICI Bank expects rates to increase in the second half of the fiscal. The bank has been able to keep away from higher-cost wholesale deposits as it had some refinancing opportunities.

With excess liquidity draining out after two years of demonetisation, banks have now realised that it is time to build up their deposits in an election year when the tightness in the system is expected to continue. Some of them may also turn to mopping up wholesale deposits. At the time to demonetisation, Rs 15.44 lakh crore of excess liquidity came into the system.

"In order to support strong credit growth, banks will need funds," said Rajiv Anand, executive director at Axis Bank. "When there is a demand for funds, cost will go up. The higher the cost of funds for banks, it is but natural that they will pass it down as higher lending rates."

Driving this change in mood is a well-diversified bank credit demand, coming from both industrial and retail segments. Bank credit grew 11.4% over the previous year while at the same time last year it saw a year-on-year growth of 4.4%.