2 min read.Updated: 27 Oct 2020, 11:09 PM ISTVivek Kaul
With deposit rates of both private sector and public sector banks falling much faster than lending rates, the banks have managed to increase the profitability of their lending business
The Reserve Bank of India (RBI) has been trying to drive down interest rates since February 2019, by slashing the repo rate, or the interest rate at which it lends to banks. Mint looks at whether this has translated into a cut in the lending and deposit rates of banks.
Between February 2019 and now, the central bank has cut the repo rate by 250 basis points to 4%. One basis point is one hundredth of a percentage. In the period between February 2019 to August 2020, the weighted average term deposit rates, or interest rate on fixed deposits, and recurring deposits, has fallen by 104 basis points to 5.86%. On the other hand, the weighted average lending rate of banks has fallen by 61 basis points to 9.65%. Even though both the deposit and lending rates have declined, the interest on bank deposits has fallen at a faster pace than on loans. This is something that banks are often accused of.
Why did interest rates not decline in tandem?
It is important to know that interest rates on deposits are fixed and aren’t linked to the repo rate, or any other external benchmark. Hence, once a bank has promised a depositor a certain rate of interest at the time of deposit, it needs to continue paying that rate of interest. For instance, if a depositor had put money in a fixed deposit that came with a promise of 8% interest a few years back, the bank has to continue paying the depositor 8% even now, though the interest rates on fresh deposits have reduced substantially. This is why lending rates never fall as fast as the repo rate.
What causes deposit rates to fall faster than lending rates?
When the interest rates are going down, banks tend to cut deposit rates faster than they increase them when interest rates are on the rise. Further, as we have seen, banks decrease lending interest rates at a slower pace than deposit interest rates. In the process, banks are able to increase the margins of their lending business and make more money.
Between February 2019 and now, the lending rate of public sector banks has fallen by 72 basis points to 9.08%, while their deposit rates have declined 84 basis points to 5.95%. The lending rates of private banks have, in that same period, fallen by 38 basis points to 10.64%, while their deposit rates have come down by 131 basis points to 5.93%. It is clear that private banks have cut their deposit rates much faster than their lending rates. However, the difference is not as big when it comes to the public sector banks.
What can be inferred from this trend?
With deposit rates of both private sector and public sector banks falling much faster than lending rates, the banks have managed to increase the profitability of their lending business. This will provide cushion against the expected bad loans following the outbreak, the effect of which will start hitting balance sheets next year. This is a cost being borne by depositors who have had to make do with far lower interest rates. There’s no free lunch in economics, after all.
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