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After a six-month hiatus, the RBI has finally resumed its rate easing policy, lowering the key repo rate — at which banks borrow short-term funds from the RBI — by 25 basis points. This is good news for borrowers on two counts. One, the rate cut has now paved the way for a further reduction in lending rates in the coming months, as banks lower their deposits rates. Two, under the new guidelines, loans sanctioned after April 1 will be priced with reference to the new marginal cost of funds-based lending rate (MCLR) and not the erstwhile benchmark base rate. Under this method, deposit rate increases or decreases immediately reflect on the banks’ cost of funds and hence, on lending rates. This can lead to further fall in the MCLR, which has already been set lower than the existing base rate.
The RBI has also announced measures to address concerns of tight liquidity conditions, critical for softer rates. (see the related story on Liquidity Matters).
More headroom
On an average, banks have reduced their base rates by 50-60 basis points through last year; such cuts accelerated after the RBI slashed repo rate by 50 basis points in its September policy.
Currently, the base rate for banks ranges from 9.3 per cent to 9.7 per cent. SBI and HDFC Bank have the lowest base rate of 9.3 per cent, with ICICI Bank follows close on their heels at 9.35 per cent. Weighted average lending rate (WALR) on fresh loans sanctioned, according to RBI’s latest report, has actually fallen by about 70 basis points in 2015.
Deposit rates, on the other hand, have been reduced by 1-1.5 per cent across tenures over the past year.
For lending rates to move lower from here, banks will first have to lower their deposit rates to bring down their cost of funds. So, how much headroom do banks have?
Remember that banks source only a small portion of their funds at the repo rate. With banks relying significantly on longer term deposits, only about 50-60 per cent of banks’ funding gets re-priced. Hence, a cut in repo rate will not immediately reduce their costs. But measures announced to ease up liquidity conditions and a reduction in the small savings rate (which compete with bank deposits) provides more headroom for banks to cut deposit rates in the coming months.
Small savings
Interest rates across post office schemes have been slashed by 60-130 basis points effective April 2016. On a like to like comparison, it is post office deposits that compete best with bank fixed deposits. The post office term deposits for five years will offer 7.9 per cent against 8.5 per cent last year. The one- and two-year post office term deposits have seen a sharper 1.2-1.3 per cent reduction in rates.
On an average, over one-year bank deposits now offer 7.25 to 7.75 per cent. Reducing the rates on small savings can thus provide some headroom for banks to lower deposit rates in the coming months.
Hence, banks are likely to lower lending rates by another 25 basis points in the next two to three months.
Move to MCLR
Currently, existing borrowers will continue to be charged interest on loans based on the earlier base rate system. While base rates will fall in the coming months, it may be wise for borrowers to migrate to the MCLR-linked loan rates.
There are two reasons for this. One, of course, is that since the MCLR takes into account the latest rates offered on deposits, banks’ cost of funds will fall more sharply as deposit rates are cut.
Two, most banks have set their benchmark MCLR 10-20 basis points lower than the existing base rate. The final lending rate can be similar or lower to the existing rates as banks can tinker with the mark-up (spread) on the MCLR. But leading banks such as SBI, HDFC Bank and ICICI Bank that can compete better on lending rates can offer good deals to borrowers. For instance, SBI has set its one-year MCLR 10 basis points lower than its current base rate. Home loan borrowers were charged 9.55 per cent interest rate, a spread of 25 basis points above the base rate. New loans priced against the MCLR of 9.2 per cent will also carry a similar spread. This means that new home loans will become 10 basis points cheaper.
Similarly, ICICI Bank has lowered its home loan rate from 9.65 per cent (based on base rate) to 9.45 per cent (based on one-year MCLR).
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