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After the unprecedented credit growth spawned by the soft
interest rate regime between 2002 and 2006, the banking
sector has slowed down significantly. Where once high growth
in the gross domestic product (GDP) had driven robust credit
growth, the banks are now faced with the effect of rising
interest rates—slowdown in disbursals, stress on asset
quality, and pressure on earnings.
Consider these facts: retail and corporate loans, which
had posted a compounded annual growth rate (CAGR) of more
than 30% till March 2007, had slowed to around 20% by March
2008. These changes were on account of increasing interest
rates, which, in turn, were due to monetary measures adopted
by the Reserve Bank of India (RBI) to counter liquidity
concerns. As the Movement of CRR, Repo Rate and inflation
chart indicates, since October 2005, RBI has increased repo
rates by 300 basis points (100bps equals 1 percentage point)
and CRR by 400bps. The inflation has increased from a low
of 3.1% in October 2007 to more than 12% in August 2008.
The increasing repo rate and CRR have driven an increase
in banks' overall costs of borrowing. The banks have sought
to counter the mounting pressure on spreads by raising their
PLRs. This rise in interest rates has resulted in a slowdown
in credit growth in the banking sector. This is also likely
to put pressure on the banking sector's earnings profile
and net profitability margin (NPM). The rising interest
rate scenario also has the potential to create significant
pressure on the asset quality of banks.
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