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Photo: Reuters
Photo: Reuters

Deposits key to banks’ marginal lending rate cuts

RBI has cut the repo rate by 250 basis points to 4% between February 2019 and last Friday, but this has not translated into banks cutting the interest rates on their loans

The Reserve Bank of India (RBI) has cut the repo rate by 250 basis points to 4% between February 2019 and last Friday, but this has not translated into banks cutting the interest rates on their loans. Will things be different this time? Mint weighs the possibility.

What has driven RBI to reduce the repo rate?

The aim behind reducing the repo rate—the rate at which RBI lends to banks—is to encourage banks to cut their lending rates. At lower interest rates people will borrow and spend more, and businesses will borrow and expand more. Over and above this, people who have already borrowed will get some relief as they will have to pay lower equated monthly instalments. It is hoped economic activity will pick up thanks to this. However, that hasn’t happened and lending growth has remained slow despite the repo rate cuts. In 2019-20, non-food credit grew just 7.6%, the slowest in nearly a decade and a half.

But why has borrowing not picked up pace?

The weighted average lending rate of banks has fallen by just 26 basis points from February last year, when this round of repo rate reductions started, to 10% in March 2020, the latest month for which data is available. Banks have largely made token cuts in their lending rates despite RBI cutting the repo rate quite rapidly. The reason for that lies in the fact that banks fund their loans through deposits. This refers to the interest rates they pay on deposits, in particular term deposits. This practice limits the ability of banks to cut their lending rates every time the central bank reduces the repo rate.

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


Have term deposit rates fallen since February 2019?

Between February 2019 and March 2020, the weighted average term deposit interest rate has fallen by 52 basis points to 6.38%. The fall in deposit interest rates has been higher than that of lending interest rates as banks aim to earn a higher interest margin to make up for bad loans. Public sector banks had total bad loans of 7,16,652 crore as of 31 December 2019.

Any other reason for the slow lending pace?

Many businesses have not grown out of the last round of borrowing binge and remain leveraged. As huge capacity lies unutilized at many manufacturing units, they have no reason to borrow and expand. Even before the covid-19 outbreak, the Indian economy was slowing, giving people less reason to borrow. One way to ensure banks pass on repo rate cuts is by varying the deposit interest rates. But that will be an unpopular move in a country where a large proportion of financial savings is in the form of bank fixed deposits.

Will banks cut lending interest rates now?

Since June 2019, the bigger public sector banks have seen a huge inflow of deposits. The State Bank of India leads this pack. On the other side, some of the weaker private sector banks have seen a huge outflow of deposits. Given this situation, the chances of one set of banks cutting lending interest rates are much better than in the past. However, on the whole, the lending rate cuts will be much slower than the overall repo rate cut. That will not change.

Vivek Kaul is a Mumbai-based economist.

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