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The odds of banks paring base rates in April have increased given that interest rates on government savings schemes have been sharply lowered.

The government on Friday pared interest rates on most of its savings schemes, including public provident funds and social schemes such as the Sukanya Samriddhi scheme. Public Provident Fund rates were cut to 8.1% from 8.7% and those on one-year time deposit have been reduced drastically to 7.1% from 8.4%. The interest rate paid by the government on Kisan Vikas Patra (KVP), which matures in 110 months, has been cut to 7.8% from 8.7% till 31 March.

Following the cuts, these rates are now comparable with bank deposit rates and in some cases even lower. Banks have often complained that small savings schemes eat into their deposit base as the rates offered are high. Indeed, banks have pared deposit rates sharply in fiscal 2016 but have been stymied in their efforts to continue to do so by high rates in small savings schemes. The one-year deposit of State Bank of India (SBI), the country’s largest bank, now offers 7.5% and most banks’ one-year deposits offer similar rates. In contrast, the government-sponsored one-year deposit offered 8.4%, which now stands reduced to 7.1%.

Bankers said the reduction in interest rates of these schemes will boost their ability to bring down deposit rates and, thus, pass on the reduction in their cost of borrowings to customers by a reduction in lending rates.

“I think this is a very good move and will lead to better transmission of the Reserve Bank of India’s (RBI’s) policy rate cuts to lending rates," said N.S. Venkatesh, executive director and chief financial officer, IDBI Bank.

The sharp slowdown in deposit growth of banks in FY14 to a 51-year-low of 11.4% underscored the problems faced by bankers in raising deposits. Part of this fall in deposits was attributed to the high interest rates offered by government schemes. Deposit growth stayed below 12% in FY15 and was 10% for the first 11 months of FY16, data from RBI showed.

RBI slashed its policy rates by a cumulative 125 basis points (bps) in calendar 2015 but banks pared lending rates only by 70 bps. “This is because high rates on small savings schemes make banks’ fixed deposits uncompetitive and, in turn, do not allow banks to reduce the cost of funds," wrote Soumyakanti Ghosh, chief economist at SBI in a note dated 21 March. One basis point is one-hundredth of a percentage point.

The sharp reduction in small savings rate, coupled with an expected cut in policy rate by RBI in its April policy, could prod banks to bring down base rates faster. Currently, the lowest base rate in the industry is 9.3% offered by SBI. “The cut is extremely well timed. The adoption of MCLR (marginal cost of fund-based lending rate) itself would have brought down lending rates to new customers. Most banks would take a call at their ALCO (asset-liability committee) meeting in the first quarter on lending rates," said an executive at a public sector bank requesting anonymity as he is not authorized to speak to the press.

RBI introduced the MCLR in December that would replace the base rate regime from April and will mandate banks to add a spread over their marginal cost of funds and a tenor premium for every maturity. MCLR is expected to reduce lending rates, especially for short-term loans.

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