BackBanks may reduce interest rates even if RBI doesn’t
Drop being led by fall in bulk deposit rates, which have dropped below retail deposit ratesa rare occurrence for the banking system
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Mumbai: Interest rates across the banking system are set to fall over the next few months, irrespective of the Reserve Bank of India (RBI) cutting the policy rate at its next review on 2 December.
Banks, which are flush with liquidity at a time when demand for credit remains low, have started the process of bringing down rates across deposit and loan products. The drop is being led by a fall in bulk deposit rates which have dropped below retail deposit rates—a rare occurrence for the banking system.
Bulk deposits are deposits of more than ₹ 1 crore and are raised from corporate clients. Typically, these come at a higher interest cost compared with retail deposits.
The minimum spread between bulk deposits and retail deposits has remained more than one percentage point in the past, but now bulk deposit rates are quoting at least 25 basis points below retail deposit rates. One basis point is a hundredth of a percentage point.
For example, most banks are offering one year retail deposits at 9%, but the bulk deposit rate for the same maturity period varies between 8.5% and 8.75%.
Low bulk deposits are prompting banks to cut retail deposit rates. The rationale being that money, if needed, can be raised at cheaper rates from corporate clients. As a result, most banks have cut their retail deposit rates by 15-25 basis points.
The net effect is that cost of deposits for banks is falling and this will eventually lead to lower lending rates, with or without a rate cut from RBI. The base rate, or the minimum lending rate, of banks is calculated based on the cost of funds. If cost of funds fall, so does the lending rate. Typically, the base rate is reset once a quarter.
Since started lowering deposit rates beginning October, by the end of the December quarter, most banks should be able to offer their customers a lower lending rate. On 15 October, Axis Bank Ltd cut its base lending rate by 10 basis points to 10.15%
“Our view is that the policy rate will come down by 25-50 basis points by March. But it seems banks’ lending rates will come down before that," said M.S. Raghavan, chairman and managing director of IDBI Bank Ltd.
According to A. Prasanna, chief economist at ICICI Securities Primary Dealership Ltd, banks are pre-empting a rate cut by the central bank.
“Banks are taking a call ahead of time that policy rates will come down and thus they are cutting their rates," he said.
RBI will announce its fifth bi-monthly monetary policy on 2 December. While analysts remain divided on whether RBI will cut rates, the clamour for a rate cut is rising due to a fall in inflation levels and a plunge in global commodity prices.
“I think interest rates now need to be moderated," said finance minister Arun Jaitley in an interview on 3 November.
Bond markets, too, are factoring in a cut in rates by RBI. The yield on the 10-year bond closed at 8.19% on Wednesday, down from 8.51% on 1 October, suggesting that the market is pricing in a 25 basis points cut in policy rates soon, possibly as early as December.
“Shape of the yield curve is signalling that we may have reduction in repo rate within the next six months," said Bank of India chairperson V.R. Iyer on Monday on the sidelines of the bank’s earnings press conference.
Bankers, however, are choosing not to wait for that final cue from RBI, since their cost of funds is more dependent on the prevailing deposit rates than on RBI’s policy rate; 90-95% of a bank’s funds come from deposits.
“RBI rates are indicative for the economy whereas banks are commercially driven," said Raghavan, adding that more than the policy rate action, RBI’s liquidity enhancement operations have helped banks.
Indeed, liquidity in the system has seen a dramatic improvement. Systemic deposit growth has remained above credit growth in recent months. As on 17 October, deposits were growing at 13.4%. Meanwhile, credit growth has fallen to almost a decade’s low of 11% as on 17 October.
As a result, most banks have surplus funds, some of which is being parked with RBI via its reverse repo operations. Banks borrowed ₹ 41,287 crore from RBI on 21 January, the highest this year so far. In contrast, they parked ₹ 45,787 crore of their excess liquidity with the central bank on 1 October. On Wednesday, banks borrowed ₹ 921 crore from RBI and parked ₹ 24,422 crore.
This excess liquidity is one of the major reasons that banks are being able to bring down deposit rates.
Another reason that bankers are comfortable cutting deposit rates without fearing an outflow is that the real rate of return (deposit rate minus inflation) on deposits is higher now than in the past two years. Hence, a small cut in deposit rates may not deter depositors.
Not everybody believes that lending rates will come down.
Rupa Rege Nitsure, chief economist of Bank of Baroda, said low credit growth and heavy inflow into the capital market have ensured that banks are awash with liquidity, but warned that the situation could reverse suddenly.
“If the credit growth picks up and there is withdrawal from emerging markets, the same banks will hasten to increase deposit rates, including that for bulk deposits," Nitsure said.
According to her, it makes sense for banks to follow signals given by RBI on interest rates as the central bank works with a long-term perspective.
“Banks will ideally not like to lower lending rate because the economy has not recovered yet and thus the risk premium is high. And public sector banks boost their capital reserve through interest income. It makes sense for them to earn more now and set aside more capital than to pass on a rate benefit to companies, who anyway are not borrowing," Nitsure added.
A banking analyst, who requested anonymity, added that the recent deposit rate cuts are being done to boost income, rather than with an intention to bring down lending rates.
“Everybody is waiting for a rate cut signal from RBI. Unless the central bank cuts its rates, many banks will not get the confidence to touch their base rate. RBI policy action does matter," said the analyst.
Even if lending rates come down, some argue that it will do little to help the economy although it could benefit individual borrowers.
According to a report by Crisil Research, released on Wednesday, investments have slowed even in years of low interest rates.
“Investment growth, particularly private corporate investment, plummeted in the fiscal 2013 and 2014, despite low real interest rates," the report said, adding the policy rate in these years, in real terms, was negative and real lending rates averaged 2.4%.
“This is significantly lower than the 7.4% seen in the pre-crisis years (2004-2008). Yet investment growth dropped to 0.3%, down from an average 16.2% seen in the pre-crisis years," Crisil’s chief economist D.K. Joshi wrote in the report.
The study showed that factors behind the recent slowdown in economic growth and investment in India have little to do with high interest rates. In this environment, RBI will do well to keep policy rates unchanged, said the Crisil report.
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