Reserve Bank of India Governor Y V Reddy on Tuesday warned banks that they could go out of business if savers decided to divert funds to the buoyant stock market and to high interest earning small savings schemes.

The RBI governor was speaking at the annual day function of the National Institute of Bank Management in Pune.

Over the past 18 months, while interest rates on bank deposits have fallen 3 percentage points, interest rates on loans fell by merely 1 percentage point.

The asymmetry between the fall in interest rates on bank deposits and loans could lead to savers chasing better returns from the stock markets and small savings schemes.

Reddy contended that if such a scenario arose, banks would no longer be in business. This could be the first public signal by the RBI governor that interest rates on deposits have bottomed out.

Reddy also expressed concern over the non-availability of credit at reasonable interest rates to small-scale industries, rural segments and government-backed enterprises at a time when big companies were reaping the benefit of lower interest rates. He warned banks of a backlash arising from this aberration.

Reddy said charging interest rates on an attributable basis would be a throwback to the Manu era, when interest rates were charged based on the caste of individuals.

He called for an objective assessment of each individual's credit profile so that trust could be built between the creditor and the borrower.

Pointing out that banks were not doing enough to reach out to rural households, Reddy said the interest rate differential between the formal and informal financial systems was large.

He emphasised that there should not be much divergence between the interest rates in the two systems. The informal financial intermediaries charge as much as 3 per cent per month interest on loans.

Reddy expressed surprise that government-backed enterprises like the Food Corporation of India and state government-backed entities were not getting the benefit of reasonable interest rates when the corporate sector was able to contract loans at sub-prime rates.

Even defaulting private sector companies have managed to bring down their interest rates on loans contracted by them with banks and financial institutions by as much as 300 basis points under corporate debt restructuring.

FCI, which has not defaulted on interest payments, has repaid its loans and is a standard asset with banks, has, therefore, tapped the debt market to raise funds at fine interest rates.

"Since banks were unwilling to lend at reasonable rates, FCI simply tapped the market," Reddy said.

He added that defaults by state government-backed entities were not more than 10 per cent. The governor expressed concern at some banks becoming only deposit-taking entities and others credit-dispensing ones.

As the credit information bureau provides the credit history of borrowers to banks, the governor suggested that bank customers should similarly be empowered to get information about banks, the products they offer and the interest rates they charge.

RBI's take on growth today

The Reserve Bank of India will present its assessment of its latest outlook on the economy on Wednesday, Reserve Bank of India Governor Y V Reddy said on Tuesday.