Reserve Bank of India (RBI) governor Duvvuri Subbarao on Friday urged banks to raise deposit rates and charge lower interest on loans in order to rev up the economy.
"We need to raise the level of national savings and channel those savings into investment.
This means banks need to raise the interest rates offered to depositors and reduce the lending rates charged to borrowers," Subbarao said in his address to the Bancon 2010 annual conference.
Subbarao said although the net interest margins (NIM) of Indian banks have come down by 0.5 per cent in the last decade to 2.5 per cent now, they continue to be higher than their peers in other emerging markets even after accounting for their mandatory social sector spends. The net interest margin is the difference between the deposit rates that banks give to customers and the lending rate they charge borrowers.
He said banks can maintain profitability by optimising operating costs like non- interest expenses, which include wages and salaries, transaction costs and provisioning expenses.
"The task for our banks clearly is to press on with efforts for sustainable reduction in operating costs through productivity improvement and skill enhancement and by leveraging technology," he said.
Nurturing asset quality, diligent loan restructuring of viable assets and reducing non- performing assets (NPA) through recovery or upgrade can be the other streams for non- interest costs reduction, he added.
Subbarao also said he is "troubled" that Indian banks see financial inclusion as an obligation rather than as an opportunity.
"Financial inclusion will provide banks access to sizeable low- cost funds as also opportunities for lending in the small volume segment," he explained.
He also said that there was a need to streamline banking regulations as some of them were confusing even though they had served the banking system well.
He came out in favour of a a single legislation to remove inconsistencies caused by a wide set of laws in the banking sector.
"There is a whole lot confusing laws out there. But it has served the system well by helping maintain an orderly banking system," he explained. " But the recent global financial crisis has taught us that our regulations have to change according to the need of the time," he added.
Subbarao also said the proposed financial sector reforms should be driven more by the sectoral regulator RBI than by a legislative panel.
Policy direction should drive the work of the proposed financial sector legislative reforms commission and not the other way around, Subbarao said.
He said the global financial crisis threw up a number of areas requiring significant legislative action either because there is no legislation or because the prevailing legislation is inadequate.
He expressed confidence in Indian banks and said they were well capitalised and can comfortably adjust to the latest international regulatory framework Basel III norms.
"Our assessment is that at the aggregate level Indian banks will not have any problem in adjusting to the new capital rules both in terms of quantum and quality," he observed.
Expressing his view on foreign banks, Subbarao said the recent crisis has made it amply clear that the subsidiary route for foreign banks doing business in the country was not free of risks.
The overseas parent could expand rapidly in boom periods by cutting into domestic lenders' margins and then pull out in a time of crisis, he explained.
" A good illustration of this tendency is what we saw happen in the European Union ( EU) in the wake of the sovereign debt crisis," he pointed out.
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