Borrowers are paying the price for banks chasing deposit growth

SBI, Bank of Baroda, HDFC Bank, Yes Bank, Canara Bank, Punjab National Bank, Uco Bank and IDBI Bank have hiked their marginal cost of funds based lending rate (MCLR) rates by 5-20 basis points (bps) since June. Whenever there is an increase in MCLR, an internal benchmark, interest rates rise on all loans linked to it. SBI’s overnight MCLR stands at 8.1% and one-year MCLR at 8.85%.

“Deposit mobilization is still slow, and banks are coming up with deposit schemes at higher rates to mobilize deposits; so, rates are not coming off," said Karthik Srinivasan, group head - financial sector ratings at Icra Ltd. “The overall increase in cost of deposits for banks has resulted in the 5-10 bps hike in MCLR. Credit is still growing faster than deposits; so banks need to raise deposits for funding."

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However, not all loan rates are linked to MCLR. In October 2019, the central bank introduced the external benchmark-based lending rate (EBLR) regime, directing banks to link their loan rates to an external benchmark like the repo rate. After this, floating interest rates for all retail and MSME loans were linked to EBLR. From 46.5% in June 2022, the share of MCLR-linked had dipped to 38.3% by March 2024. Alongside, the share of EBLR-linked loans rose to 57.5% from 46.9% over the same period. Corporate loans are still linked to MCLR, although some banks have started offering top-rated corporates short-term loans on external benchmarks.

“Banks are possibly hopeful that rates will start coming down in two-three months, and they are trying to protect their margins to the extent they can through these small MCLR hikes," Srinivasan of Icra added.

Deposit Rates Outpace Lending

Deposit rate hikes have outpaced increases in lending rates, as deposit growth continues to lag credit growth. The weighted average lending rate on outstanding loans has risen 102 bps from 8.79% in May 2022 to 9.81% as of May 2024, and on fresh rupee loans by 153 bps from 7.86% to 9.39%. In comparison, weighted average deposit rate on outstanding term deposits rose 185 bps from 5.07% to 6.92% over the same period, and on fresh term deposits by 226 bps from 4.21% to 6.47%.

In an effort to raise deposits in a competitive environment, some banks, especially mid-sized private banks and small finance banks, have been offering attractive one-time rates as high as 7% on certain high-value savings accounts of above ₹200,000.

Also read | Banks rush out deposit rate hikes in scramble for cash

The Reserve Bank of India (RBI) has increased repo rate by 250 bps between May 2022 and February 2023. In comparison, the median one-year MCLR for banks has increased by 160 bps from 7.25% to 8.85% as of June 2024.

Banks compute MCLR by calculating all operating costs as a percentage of the marginal cost of funds, on the basis of which the lending rate threshold is determined. MCLR for different loan tenures is reviewed every month by the bank's asset-liability committee, based on the deposit rates and cost of funds.

“MCLR is formula-based and usually rises when the cost of funds go up. Cost of funds, in turn, have gone up because of the increasing deposit rates on certain buckets or tenures," said Madan Sabnavis, chief economist at Bank of Baroda.

“Some banks have also been raising bulk deposits from corporates, either for their asset-liability management or because some specific players may be facing a liquidity shortfall. Because of this too, cost of funds has gone up and possibly translated to MCLR hikes."

Also read | RBI to keep repo rate unchanged, focus on liquidity: Mint poll

Over the past two years, a significant portion of incremental lending has been on the consumer side, which is EBLR-linked. So, an increase in MCLR has been pending for quite some time and some normalization may be happening there, said a senior official at a mid-sized bank.

“Corporate and infrastructure lending remains muted, but banks are highlighting some amount of pick-up, also may be because it is a good way to defend the hike in lending rates and protect their margins," the official added.