DYK: Banks don’t have to change lending rates with change in repo rate
From April this year, RBI has asked banks to move to the new marginal cost-based lending rate
Since January 2015, the Reserve Bank of India (RBI) has cut its key policy rate or the repo rate by a total of 150 basis points. One basis point is a one-hundredth of a percentage point. The repo or repurchase rate is the rate at which banks borrow from the RBI. There is an expectation that repo rate reduction should result in banks decreasing their lending and borrowing rates as well. However, this has not happened completely as banks have transmitted only about half of this through lending rate cuts.
BANKS’ COSTS OF FUNDS
Banks typically fix their lending rate in a manner that covers their own cost of borrowing and leaves them a margin of profit. A change in repo rate has a greater impact on the lending rate and the overall cost of funds for a bank if it is heavily dependent on RBI’s liquidity provision for funding its business. This is not the case for many commercial banks in India as they rely more on deposits to fund credit growth.
Deposit rates are competitive, at present around 8-8.5% for a fixed deposit with a tenure of one year. Given that banks are borrowing at a rate much higher than the repo rate, it is unlikely that lending rates will fall too much.
Where a bank’s loan book is linked to a fixed rate, this change can happen proactively. However, if majority of a bank’s loans are on a flexible rate, then the change is seen to be more gradual. This is because a reduction in the overall lending rate without a parallel reduction in deposit rates will impact banks’ operating margin negatively, which is undesirable.
RECENT CHANGES COULD HELP
From April this year, RBI has asked banks to move to the new marginal cost-based lending rate (MCLR). All new flexible rate or floating rate loans will get linked to MCLR, which is linked to actual deposit rates. Each bank HAS multiple MCLRs depending on the different tenures. At the moment, MCLRs are not too different from the earlier base rates; experts say transmission issues will remain.
Additionally, the government announced a slew of rate cuts in small savings securities and schemes. Bank fixed deposits compete with such schemes and this move lends itself to the banks’ ability to reduce elevated deposit rates, thereby bring down cost of funds.
Moreover, RBI has been committed to liquidity management through other routes like open-market purchases.
All these put together are expected to ease the cost of borrowing for commercial banks, which can lead to a reduction in lending rates.
Nevertheless, as corporate balance sheets already have high debt and individual consumption growth is subdued, bank credit growth might not pick up pace too fast. This could negatively impact the decision to lower lending rates too quickly.
Thus, it is not a repo rate cut alone which can impact the rate at which banks lend. Other factors need to fall in place as well.
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