The move will only affect SBI savings account holders with a balance above ₹1 lakh
Starting 1 May, SBI will link savings bank deposits above ₹1 lakh and short-term loans like overdraft with RBI’s repo rate
In a major development that could eventually lead to significant improvement in interest rate transmission for consumers, State Bank of India Ltd (SBI) on 8 March announced the linking of savings bank account deposits and short-term loans to the Reserve Bank of India’s (RBI) repo rate. RBI had in December asked banks to link all new floating rate retail loans like home loans with an external benchmark from 1 April 2019. The central bank is yet to issue the final guidelines in this regard.
The current SBI move will not only affect its customers, but also customers of other banks in general as it could define the way deposit and lending rates will be fixed in the future. Here’s what this means for you.
The SBI move
Starting 1 May, SBI will link savings bank deposits above ₹1 lakh and short- term loans like overdraft with RBI’s repo rate. This is the rate at which the central bank lends money to banks, when the latter face shortage of funds. RBI reviews, but not necessarily changes, the repo rate in every bi-monthly monetary policy.
With SBI linking rates for such deposits and loans to the repo rate, the change will be automatically transmitted. For instance, if the RBI cuts its repo rate by 25 basis points or bps, the interest rate for your savings bank account having over ₹1 lakh will come down by 25 bps. One bps is a hundredth of a percentage point. At the same time, the interest rate you were paying on a short-term loan like overdraft or cash credit will also come down by 25 bps.
In its bi-monthly policy meeting in February, RBI cut the repo rate to 6.25%, which is likely to come down further as a rate cut is widely expected in April. SBI currently gives a 3.5% interest for savings account deposits of up to ₹1 crore. After the latest linking of this rate with the repo rate for deposits over ₹1 lakh, the effective rate remains at the same level of 3.5%, which is 2.75% below the current repo rate. The mark-down is fixed by the bank.
For short-term loans of over ₹1 lakh, a spread of 2.25% over the repo rate will be charged, taking the floor rate to 8.5% currently, which is very close to the current marginal cost of funds-based lending rate (MCLR) at 8.55%. The actual rate charged from you, the customer, will also include a risk premium based on your credit profile, like it is currently done.
According to P.K. Gupta, SBI’s managing director, about 98% of the bank’s savings account holders will not come under this repo rate-linked interest rate as the balance in these accounts is less than ₹1 lakh. However, in terms of value, about 80% of the savings account deposits will be covered, he added.
For the bank, this move is expected to improve the asset-liability management. Madan Sabnavis, chief economist at Care Ratings Ltd, called it a smart move by SBI. “Deposits have not been growing at an adequate pace for banks. So one issue was how do you get more deposits converted from savings bank deposits to fixed deposits. The latest move by SBI is in a way telling customers to convert their savings account deposits into term (fixed) deposits to get a fixed rate if they have over ₹1 lakh in their accounts. It will improve their asset-liability management because some short-term deposits will get converted into medium term deposits," he said.
What it means for you
If you are an SBI savings account depositor with over ₹1 lakh lying idle in the account, you will lose out if repo rates go down further. “In that case, I will gain if I move that money to a fixed deposit," Sabnavis said.
If you are not an SBI customer, you will not be directly impacted by this change. However, the move is being seen as an important development, and could lay the foundation for determining interest rates on loans like home loans when they are linked to external benchmarks.
Gupta said, with this move, a significant portion of the bank’s balance sheet, both on the assets and liabilities sides, will be linked with the policy rate, which will mean that the transmission will happen automatically whenever the policy rate changes. “In the process, a lot of loans will get benchmarked to the external benchmark. We will link other loans as well with the external benchmark over a period of time. Let us see how this experiment goes," he said.
Over the past many years, banks have been reluctant to pass on the rate cut benefits to borrowers but have passed on the cut to depositors faster. Similarly, in case of policy rate hikes, banks have been observed to keep the deposit rates low, while increasing the interest rates on loans.
While RBI is yet to issue final guidelines on external benchmarking of floating rate retail loans, the new system adopted by SBI will also have a bearing on MCLR that helps determine interest rates for other loans like home loans.
MCLR goes down when banks’ cost of funds reduce, and that happens when deposit rates are lowered. Sabnavis said that the only way for banks to reduce their cost of funds is by reducing the cost of deposits. “Changing the deposit rate is completely under the bank’s control. Linking deposit rates with the repo rate will automatically have a direct impact on the overall cost of funds of the bank. As it happens automatically, the transmission will also be smoother," he said.
However, banks have been unable to reduce rates on fixed deposits as doing that could slow down deposit collection which could further impact their lending capacity. “Despite a recent cut in repo rate, banks were struggling to reduce their lending and deposit rates as the deposit accretion continued to lag credit growth. Cutting deposits rate was not a feasible option for banks amid slowing deposits growth," said Anil Gupta, sector head, financial sector ratings, Icra Ltd.
For SBI, savings account deposits make 38% of the total deposits and a 25 bps reduction in the interest rate on these deposits could lead to a 7-10 bps reduction in the bank’s MCLR, said P.K. Gupta. Interest rates paid on deposits—savings as well as fixed—are an important variable in the calculation of the cost of funds of a bank.
More banks are expected to follow in the footsteps of SBI and adopt this practice of pricing deposits with an external benchmark. “We expect more banks especially all public sector banks and a few large private banks to follow the move by linking their deposit and lending rates to repo rate which will also be in line with RBI requirements to link these rates to external benchmarks," Anil Gupta said.
It now needs to be seen when the external benchmarking of retail loans like home loans comes into effect, as the implementation could make loan pricing much more transparent.