A cut in lending rate is not what you expect when all signs point to interest rates rising from here on. But ironically the country’s largest lender, State Bank of India (SBI), pruned its base rate by 30 basis points on Monday.
A basis point is one-hundredth of a percentage point.
SBI’s logic was that it is passing on the full benefits of lower interest rates to that set of customers who were left out in the declining interest rate period. These are borrowers that make up nearly a quarter of the lender’s loan book. To be sure, SBI had already lowered deposit rates to make this cut gentle on its net interest margin.
The base rate cut also followed several critical observations by the Reserve Bank of India (RBI) about the way banks calculate their base rate and even the more recent marginal cost of funds based lending rate (MCLR).
The central bank admonishing banks over interest rate transmission is not new, but what is new is the intensity with which RBI has been doing so lately. RBI has accused banks of arbitrarily arriving at interest rates and spreads over base rate and MCLR, making transmission an opaque process.
RBI had observed that while banks have had to pass on the full benefits of policy rate cuts onto MCLR, base rates weren’t being lowered with the same gusto. The committee set up by the central bank last October to look into transmission accused banks of undermining the integrity of the interest rate setting process. It is understandable that the largest lender takes the lead in righting a wrong by passing on lower interest rate benefits to all customers democratically so that every borrower feels included and therefore SBI can aim for greater customer loyalty.
Considering that SBI has clipped its base rate, banks that don’t have a large part of their loan book still linked to base rate can cut theirs easily. Those that still have a sizeable portion of their loan book linked will have to either sacrifice margins or risk sacrificing market share to SBI.
However, this is as good as it gets on the interest rate front. The SBI management was non-committal on whether further cuts are possible or even a cut in MCLR is possible. The conditions for further interest rate cuts—surplus liquidity and policy rate cuts—are slowly evaporating.
Considering that government bond yields have soared, SBI’s base rate cut is nothing but a last hurrah for borrowers before their interest rates start inching up.