Banks set to raise lending rates, pre-empting RBI

India’s struggling economy is facing a new challenge: Banks are raising interest rates even though the Reserve bank of India (RBI) is leaving its rates unchanged, as risks such as surging bond yields and more provisioning requirements erode their profit. HDFC Bank, the country’s second-biggest bank by assets, on Wednesday became the latest to raise some rates by 10 basis points. The same day, the Reserve Bank of India kept its policy rate unchanged, to “carefully” nurture economic growth.

Other major banks are likely to follow suit, raising concerns of de facto rate increases in an economy that is growing at its slowest pace in three years and needs private investment.

An RBI staff study showed every 100 bps increase in borrowing costs lowers the investment rate by as much as 91 bps. “Lending rates will move up. We cannot avoid that from happening,” said the chief of a large state-run bank.

Banks are facing a number of threats. Chief among them is that rising inflation has hurt bonds, driving benchmark 10-year yields up more than 100 bps since July, a big concern for banks, which are the biggest buyers of the debt.

Banks are also facing a higher cost of funds, a key expense for the lenders, and more stringent regulatory requirements for their liquidity coverage ratios, as per Ashish Parthasarthy, treasurer at HDFC Bank.