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Photo: iStock

Bonds winning over loans in race for rate cut transmission

The weighted average lending rate for fresh loans fell by 91bps between Mar and Aug, according to an RBI report

India’s banks have transmitted policy rate cuts faster after the pandemic than they did earlier but loans are still far from being cheaper than bonds. The monetary policy report of the Reserve Bank of India (RBI) shows that the weighted average lending rate for fresh loans fell by 91 basis points (bps) between March and August, higher than the 71bps drop in the one year before the coronavirus outbreak. One basis point is one-hundredth of a percentage point. On the other hand, the five-year top-rated corporate bond yield has dropped by a smaller 79bps. The drop in yields of corporate bonds with one-year and three-year tenures is larger. Even so, analysts note that banks have been able to retain their pricing power.

The difference between State Bank of India’s marginal cost of funds-based lending rate (MCLR) and corporate bond yields has widened, according to Jefferies India Pvt. Ltd. India’s largest lender has been able to keep lending rates from falling sharply and those of other lenders are likely to be higher.

Reaching for the bottom
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Reaching for the bottom

One way banks are able to keep lending rates from falling sharply is by managing credit spreads. The management of spreads has meant that the benefit of increased transmission is uneven across sectors. Housing loans have been the biggest beneficiary as the spread charged by banks over the repo rate has been minuscule.

On the other hand, spreads for micro, small and medium enterprises loans have been wider.

For instance, the weighted average lending rate for outstanding housing loans has been 8.2%, just 50bps higher than the MCLR. The median spread over the policy repo rate was just 40bps. For MSMEs, the spread was a massive 240bps. The weighted average lending rate worked out to 10.2% for such companies. Many MSMEs may not be able to access the bond market, but those that do are able to borrow slightly cheaper than loan rates.

The three-year AA-rated corporate bond yield, perhaps the most commonly used by smaller companies, has dropped by 302bps between March and September, according to the RBI report. In other words, bonds are still cheaper for companies.

As such, the corporate bond market has become cheap for most issuers for short-term money. The commercial paper rates have dropped sharply, with some issuers able to raise at rates comparable with the risk-free sovereign treasury bills. The RBI’s measures to keep bond yields under check would ensure that the bond market remains a cheap source of funding.

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