Photo: Mint
Photo: Mint

Lending rates yet to keep pace with cuts in repo rate

In the past 2 years the difference between the interest a private bank charges on a fresh loan on an average and the interest its public sector counterpart charges on a fresh loan on an average has gone up. The increase in the difference of the two rates is one of the reasons why monetary transmission hasn’t taken place

The next monetary policy statement of the Reserve Bank of India (RBI) is scheduled for 4 October. The monetary policy committee (MPC) of the central bank is widely expected to cut the repo rate again. Will this translate into cuts in lending rate of banks? Mint takes a look.

Have repo rate cuts lowered lending rates?

The monetary policy committee has cut the repo rate, the interest rate at which RBI lends to banks, by 110 basis points from 6.5% to 5.4% during 2019. One basis point is one-hundredth of a percentage point. However, the cut in the repo rate hasn’t translated into lower interest rates, even on fresh loans issued by banks. In December, the weighted average lending rate on fresh loans given by banks was 9.79%. By July 2019, the rate had fallen by just two basis points to 9.77%. Between January and July, MPC cut the repo rate by 75 basis points. Clearly, the monetary transmission, as RBI had expected, hasn’t happened.

Why is monetary transmission stuck?

The interest rate at which private sector banks (PSBs) lend money tends to be higher than the interest rate at which public sector banks do so. In the past two years the difference between the interest a private sector bank charges on a fresh loan on an average and the interest its public sector counterpart charges on a fresh loan on an average has gone up. Two years ago, in August 2017, the difference between the two rates was 35 basis points. In July this year, the difference jumped to 103 basis points. The increase in the difference of the two rates is one of the reasons why monetary transmission hasn’t taken place.

What is the reason for this huge difference?

Several PSBs came under RBI’s prompt corrective action (PCA) framework, restricting their lending activities. Reduced competition from PSBs may have led private banks not to cut rates.

Graphic: Paras Jain/Mint
Graphic: Paras Jain/Mint


Has RBI pulling banks out of PCA helped?

Data suggests public sector banks coming out of PCA has created more competition for private banks. The difference between the lending rates fell from a high of 144 basis points in March to 103 basis points in July. Reduced competition is not the only reason for private banks charging a higher interest rate than that of PSBs. The average interest rate at which private banks borrow money has also risen during the past two years. This, along with less competition, is reflected in the higher interest rates charged by private banks.

Why have pvt banks’ borrowing rates risen?

Household financial savings have fallen in the past few years. Besides, the public sector borrowing requirement—the sum of the Centre’s fiscal deficit, its off-budget borrowing, fiscal deficits of state governments and borrowing by central public sector enterprises—has risen to 8.5-9% of GDP. This has led the government to borrow more, left lesser savings for the private sector to borrow from and pushed up private banks’ lending rates.

Vivek Kaul is an economist and the author of the Easy Money trilogy.

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