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Wednesday, May 30, 2018

LOANS - Get Ready to Pay Higher EMIs

LOANS - Get Ready to Pay Higher EMIs
Vivek Kaul's Diary 
Wed, 30 May 2018

Yogi Berra, the famous American baseball coach used to say, "It's tough to make prediction, especially about the future."
With this disclaimer up at the very beginning, let me make a prediction: Interest rates are all set to rise. Get ready to pay higher EMIs.
India has had low interest rates for a while. That is set to change. And in the months to come, interest rates will go up.
Why do we say that? Take a look at Figure 1, which plots the incremental deposit ratio of banks, over the last four years. (Okay, we know, incremental credit deposit ratio sounds like something very difficult to understand. Keep reading. Let's assure you, it's not).
Figure 1:
The incremental credit deposit ratio is obtained by dividing the total loans given out by banks in the last one year by the total deposits raised by banks during the same period. In case of loans or credit, we consider the non-food credit number. Banks in India give loans to Food Corporation of India and other state procurement agencies to primarily buy rice, wheat and pulses, directly from farmers. Once we remove these loans from the total credit, what remains is the non-food credit.

It is clear from Figure 1 that over the last six months, the incremental credit deposit ratio has been greater than 100%. In November 2017, the incremental credit deposit ratio touched a high of 223%.
What does this mean? It means that banks have been lending more than they have been borrowing (in the form of deposits). Banks have managed to continue lending simply because a surfeit of deposits landed up with them in the aftermath of demonetisation.
Now take a look at Figure 2 which basically plots the credit deposit ratio.
Figure 2:
Credit deposit ratio is basically the total loans of given by banks at any point of time divided by the total deposits the banks have at the same point of time.
Figure 2 tells us that over the last few months, the credit deposit ratio of 74% or more. What does this mean? It basically means that 74% or more of bank deposits have been given out as loans.
It needs to be kept in mind here that banks need to maintain a cash reserve ratio of 4% with the Reserve Bank of India (RBI). This basically means that banks need to maintain Rs 4 out of every Rs 100 of deposit, as a reserve with the RBI.
Over and above this, banks need to maintain a statutory liquidity ratio of 19.5%. This means that Rs 19.5 out of every Rs 100 of deposits, needs to be compulsorily invested in government bonds.
This means that Rs 23.5 out of every Rs 100 of deposits raised by banks, cannot be loaned out. That leaves Rs 76.5. 76.5% of bank deposits can be given out as bank loans. Currently, the credit deposit ratio is at 74.24%. This of course considers just non-food credit. Over and above this, there is food credit to consider as well. So banks have very little leeway available to continue to lend more, at the current level of deposits.
Of course, deposits are not the only form of funding available to banks, but they continue to be the major form of funding. Deposits typically tend to for 92-93% of the total liabilities of banks.
With very little leeway available for lending remaining at the current level of deposits, interest rates are bound to go up. Of course, as has been seen in the past, banks increase interest rates on loans much quicker than the rates of interest that they pay on their deposits.
A few more points need to be considered here:
1) As interest rates go up, borrowers will have to pay higher EMIs on their loans.
2) Interest rates and bond prices are negatively correlated. This means that as interest rates go up, bond prices will fall. In this scenario, banks will lose money on their available for sale bond portfolio. This will happen in a scenario, where bad loans of banks have already touched a close to Rs 10 lakh crore.
3) Also, it needs to be mentioned here that 11 out of 21 public sector banks have been put under preventive corrective action by the Reserve Bank of India. Of these banks, the Dena Bank and the Allahabad Bank, have been barred from lending. As far as other banks under the preventive corrective action framework are concerned, they are afraid of lending, in order to avoid ending up accumulating more bad loans. A bad loan is essentially a loan which hasn't been paid for 90 days or more. In this scenario, where many banks are not in a position to lend, interest rates are bound to go up.
4) Corporates looking to raise short-term loans have already started to pay higher rates of interest on these loans.
To conclude, interest rates will go up in an environment of higher oil prices and rupee losing value against the dollar. This will add to the inflation or the rate of price rise. Not something that a government which is getting ready for elections in the next 12 months, is going to like. But that's how it is looking right now.
Stay tuned!
Vivek Kaul
Vivek Kaul
Editor, Vivek Kaul's Diary
LOANS - Get Ready to Pay Higher EMIs Reviewed by Investment Guru on May 30, 2018 Rating: 5 LOANS - Get Ready to Pay Higher EMIs Vivek Kaul's Diary   Wed, 30 May 2018 Yogi Berra, the famous American baseball coach us...

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