Interest rate cycle turns upward, but transparent loan pricing soon

5 min read 27 Dec 2018, 03:44 PM IST Join us

Shaikh Zoaib Saleem

The major developments in the banking sector were turning of the interest rate cycle after about four years and the proposal to bring in external benchmarks for retail loans to ensure fair rate transmission

There were some new developments during the year that were good for you and others that were not so good. Photo: Mint

At the start of 2018, banks started increasing deposit rates and then moved on to gradually raising lending rates as well, even before the Reserve Bank of India (RBI) raised its benchmark repo rate. This is the rate at which banks borrow short-term funds from RBI.

But just a month into 2018, doomsday predictions on bank deposits started making rounds on social media as an announcement of ₹ 11,400 crore worth fraudulent transactions in Punjab National Bank came up. This was when the total non-performing assets of the banking sector were already close to ₹ 10 trillion. However, your deposits remained safe, retaining the gilt edge of perception around fixed deposits.

Meanwhile, there were some new developments during the year that were good for you and others that were not so good. Typically, every change in the sector matters as it impacts your savings in some way. Here’s a look at major developments in the banking space that had a direct bearing on you.

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While banks had already started raising deposit and lending rates, RBI increased its benchmark repo rate only in June. The upward revision in RBI rates came after over four years. Before June this year, the last time the repo rate was revised upwards was in January 2014, from 7.75% to 8%. The June rate hike was followed by another 25 basis points (bps) hike in August, taking the repo rate to 6.5%.

RBI has not increased rates since then. In a post-monetary policy press conference, then RBI governor Urjit Patel had said that rate cuts were off the table in the current rate cycle and that the central bank wouldn’t hike rates at every meeting. However, inflation has remained low and crude oil prices have declined since then. “At this moment, in an environment where inflation is benign and oil prices have also come down, it is fair to say that RBI has perhaps moved from a tightening to a neutral environment. But whether they will cut rates or not will depend on the behaviour of the US dollar as well as oil prices as we go forward, but it is fair to say that risk is on the downside," said Rajiv Anand, executive director - retail banking, Axis Bank Ltd.

It has been observed in the past that transmission of RBI rate changes by banks to consumers has been poor. So when interest rates go up, they don’t come down easily for loans. But deposit rates are sticky at lower levels, and when rates increase, deposits rates don’t increase proportionately.

Now that may change. RBI has said that all new retail and small business loans with floating rates, taken on or after 1 April 2019, will now have to be benchmarked against external benchmarks such as RBI’s policy repo rate, 91-day treasury bill yield, 182-day treasury bill yield or any other benchmark market interest rate produced by Financial Benchmarks India Pvt. Ltd (FBIL).

While external benchmarking of floating retail loans is expected to improve transmission of rates and transparency of pricing of big-ticket loans like home loans, it may also increase volatility in interest rates. Moreover, the directions are only for banks, and close to half of home loans are taken from NBFCs. RBI is yet to release the final guidelines.

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Banks have been under pressure due to non-performing assets in their corporate loan book. This has meant increased focus on retail loans. Over the past few years, the share of retail loans in banks’ non-food credit has gradually gone up from around 18% at the beginning of 2014-15 to about 25% in October 2018, as per data from RBI.

“The focus of banks, especially public sector banks, has been on retail assets. To that extent, the focus has changed from corporate to retail, and that has also led to strong competition among public sector banks. That has led to a finer pricing for products like home loans for a consumer. Retail continues to remain a favourable asset class for the banking sector," said Anil Gupta, vice-president, sector head - financial sector ratings, ICRA Ltd.

In September 2018, some of IL&FS group companies defaulted on their debt obligations. This led to shortage of liquidity in debt capital markets and bond yields went up. Other NBFCs also got impacted. As a result, NBFCs adopted stricter practices for disbursal of loans, including retail loans. “Because of the issue of liquidity in the NBFC space, they are out of competition to some extent, and that has led to the banking sector gaining some pricing power. There can be an upward movement in lending rates to some extent," Gupta said.

This year also saw RBI making its dislike for cryptocurrency clear. While the regulator had been flagging the risks associated with cryptocurrency for quite some time, it prohibited regulated entities like banks and payment gateways from providing services to entities dealing in cryptocurrencies, effective July 2018.

While some cryptocurrency exchanges have come up with peer-to-peer trading and some have also gone to the Supreme Court against RBI’s directive, interest in crypto assets appears to be dwindling. One of the first and biggest cryptocurrency exchanges, Zebpay, stopped operations in September. Also, trading volumes have drastically declined for existing exchanges. This is in line with the steep fall in the price of Bitcoin, the most popular cryptocurrency. Since its peak of close to $20,000 in December 2017, it has crashed to around $3,700 currently.

While it had become simple to open a bank account digitally using your Aadhaar number, that has stopped after the Supreme Court judgment in September prohibited private companies from using Aadhaar. However, this might soon get addressed as the government is taking steps to bring in legislative changes to enable voluntary use of Aadhaar for the purposes of KYC.

Also, by the end of December all card holders will need to replace their magnetic stripe cards with chip-and-PIN cards. This will enhance the security of the cards and is expected to curb skimming frauds.

In 2019, it needs to be seen how the implementation of the external benchmarking of interest rates takes place. It will become even more interesting if interest rates start going downwards.

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