Banks cut lending and deposit rates

Starting last week of October, top banks have been revising their lending and deposit rates. State Bank of India (SBI), the country’s largest lender, reduced its marginal cost of funds based lending rate (MCLR) by 15 basis points (bps). MCLR is the new benchmark lending rate at which banks will lend to new borrowers. One basis point is one-hundredth of a percentage point.

SBI links new home loan interest rates to 1-year MCLR, which now stands at 8.90%, compared to 9.05% earlier. SBI has a spread on home loans at 20 bps for women and 25 bps for other individuals. Hence, the interest rate on SBI’s home loans for these two groups would be 9.10% and 9.15%, respectively. Rates of all the other loans linked to MCLR—such as auto loans and personal loans—would also reduce by 15 bps.

Besides cutting the lending rates, on 24 October, SBI also slashed the interest rate on its fixed deposits (FDs). SBI now offers 6.50% interest on FDs in the 3- to 10-year maturity basket. Its 5-year interest rate on FDs is 130 bps lower than the 5-year post office term deposit rate. The interest rate difference between the small savings products and bank FDs has been steadily increasing. The interest rate on 1-year FD is now at 7.05%, compared to 7.15% earlier. SBI’s rate cut is an indicator that the deposit and lending rates are set to fall further in the banking industry.

ICICI Bank Ltd, the country’s largest private sector bank based on assets as on 31 March, has also reduced its MCLR. Its 1-year MCLR was cut by 10 bps to 8.95%. If the spread on home loan continues to be around 25-30 bps, it would offer home loans at interest rates of 9.20-9.25%, for loans of up to Rs5 crore. State Bank of Bikaner has revised its one-year MCLR to 9.45%.

Other banks such as Yes Bank Ltd, Corporation Bank, Dena Bank and South Indian Bank Ltd have revised MCLR for various tenures.

Revision rationale

These cuts in deposit and lending rates come in the wake of Reserve Bank of India (RBI) slashing the repo rate by 25 bps in the October monetary policy review. RBI governor Urjit Patel had then raised concerns about the earlier cuts in bank rates not getting transmitted to retail lending. The rate cuts may be the banks’ way of responding to the central bank’s concerns.

The rate cuts in the last monetary policy were considered soft by many, indicating excess liquidity in the banking system. However, bankers have been expressing concerns about an outflow on account of foreign currency non-resident (FCNR) deposits that are maturing in the September-November period, which will impact the deposit base. According to Bloomberg data, in the first two weeks of October, there has already been an outflow of close to $6 billion out of the $20 billion of FCNR deposits. “Since RBI has cut repo rate, and g-sec (government securities) yields have come down, it indicates that interest rates are on a downward trajectory. Also, large banks may not be affected by FCNR deposit outflows,” said Siddharth Purohit, analyst, Angel Broking Pvt. Ltd.

Impact on loans

The fall in MCLR means that loans would be cheaper for new borrowers. As of now, new home loans are either linked to 6-month or 1-year MCLRs. The MCLR rates get revised every month. These loans come with a reset clause based on the tenure of the MCLR it is linked to. So, if your home loan is linked to a 1-year MCLR, it will get reset every year. If you are looking to take a loan, go for a floating rate as the interest rates are on a downward path. Remember that all banks typically lend with a spread on the MCLR. Usually, the rates are 25-50 bps higher than the MCLR.

In a falling interest rate regime, go for a floating rate loan. Remember, fixed rate loans are usually more expensive than floating rate loans and come with other charges as well as prepayment penalties. You also have to incur higher costs, in case you want to switch your loan from a fixed rate to a floating rate. “Even the existing customers, who are on base rate regime, may get the benefit of falling rates soon. Being on floating rate is a better choice at this point. Banks may want the customer to be on fixed rates, hence, guard yourself,” said Suresh Sadagopan, a Mumbai-based financial planner.

Impact on fixed deposits

When it comes to FDs, the interest rate has been on a downward trajectory. SBI cutting interest rates on FDs to 6.50% on most tenures, is an indicator that rates on deposits may fall further. For an individual in the 30.9% tax bracket, 6.50% annual return from an FD would get reduced to a net return of 4.50% post-tax. In case you fall under the 10.3% tax bracket, your post-tax return would be 5.8%.

Factor in inflation, and the real return will come down further. However, if you still want to stick to FDs, you may want to lock in immediately. “When SBI is offering 6.50-7% interest rate on FDs, it appears like they have enough liquidity because the rates are very low. If you are looking for other products, factor in liquidity, tenure and risks attached to an investment instrument. At this moment, you may want to look at debt funds,” said Sadagopan.

Corporate FDs may give 200 bps higher returns, but remember to weigh the risk attached to it.