The Reserve Bank of India (RBI) announced a rate cut of 25 basis points at its monetary policy meeting on 7 February, but there has been a lot of apprehension about how much of this will actually benefit consumers, given instances of poor rate transmission in the past. Lending rates never went down by the same proportion as the policy rate cut. But RBI seems to have taken note. The RBI governor recently met banks to nudge them towards better transmission of rate cuts to customers, but will that yield any results in the near future? Nilanjana Chakraborty asks experts if the nudge will work
Lending rates can’t be cut unless deposit rates go down
Arate cut does not mean that the cost of funds for banks goes down. What has been cut is the borrowing rate and the liquidity adjustment facility, where they pledge government securities (G-secs) and take temporary liquidity to ease cash flows. To give loans, banks need permanent sources of liability, which are deposits. But deposit rates have not come down, and no bank can afford to cut them as credit growth has been strong. Banks are unlikely to cut deposit rates given the slow deposit build-up and better interest rates on some small saving schemes. Some banks recently cut their benchmark rates, marginally. However, none of the banks have cut deposit rates. Lending rates can’t be cut unless deposit rates are reduced.
Given RBI’s nudge, public sector banks will have to follow the diktat. In such a scenario, private banks will have to follow suit because they want to stay competitive. Benchmark rates may go down, and if loans are linked to benchmark rates, they will get repriced.
Big shake-up for loan consumers will happen only in next FY
We’ve moved from one interest rate benchmarking regime to another but the concern is diluted transmission of rate cuts. Banks, which must guard against NPAs, also need to protect their margins.
Nevertheless, the immediate concern stems from the fact that RBI had announced an unexpected but welcome 25 basis point cut in repo rate, but a few banks have passed on the benefit to customers only up to 5 to 10 basis points.
Following RBI’s nudge, we may expect to see marginal improvement. But the big shake-up that borrowers are looking for will only happen in April when banks move to external benchmarks and will need to fix their spreads in a more transparent manner. With the new norms, consumers can hope to avoid low rate transmission.
So, consumers who feel their loan rates are too high should wait till March and take stock of their options in April, when the credit market will be transformed with the arrival of attractively priced products.
It will take time for rate cut transmission to become visible
The rate cut has happened, but one needs to recognise that liquidity in the system continues to be tight. This is also demonstrated by the fact that RBI is pumping in liquidity every month through bonds.
Banks are raising FD rates, and the rates continue to be high because liquidity is less. The amount of currency in circulation is also on the rise, which is adding to the shortage of liquidity in the system.
Therefore, while there will be some rate cuts, it will take some time before the transmission happens. We need to recognise the facts that currency circulation is going up, household saving rates have been falling, and there is typical year-end constraining of liquidity. It will take time for the rate cut transmission to become visible.
Then end of the financial year is around the corner, as are the general elections; so we need to be patient about this. These are events that need to be worked through and then we can see what the situation is on the other side.
External benchmarking will make the real difference
It has been observed that the transmission of policy rates has been slow. This is because RBI cuts the repo rate, which is the cost at which banks can borrow overnight funds from RBI and constitutes a very small part of the total borrowing of banks. About 90% of the funding is through deposits which are at fixed rates.
Data shows that year-on-year growth of deposits has been lagging credit growth, intensifying competition to attract savings. This reduces the possibility of reduction of deposit rates and, in turn, MCLR (marginal cost of lending rate). But even when deposit rates move down, rate transmission is hindered as banks try to preserve margins to provide for stressed assets and operating costs.
However, April 2019 onwards, the rate transmission is likely to become swift for smaller loans as banks migrate to link floating rate retail loans to one of the four external benchmarks. Benchmarking will curtail banks’ influence on lending rates, making transmission smoother.