RBI maintains status quo; lending rates to fall gradually hereon

Radhika Merwin BL Research Bureau | Updated on January 17, 2018 Published on August 09, 2016


Muted credit growth and banks’ focus on balance sheet clean-up can impede smoother transmission despite ample liquidity

With the RBI choosing to hold rates yet again, borrowers can expect only modest cuts in lending rates hereon, mostly leftovers of the pass-through of the policy rate cut thus far. While the slew of measures announced by the RBI in its April policy has improved the liquidity situation -- key for smooth transmission of rate cuts -- weak investment activity and niggling bad loan concerns have reduced banks’ leeway to lower lending rates. As the rate-easing cycle (150 basis points cut since the beginning of 2015) nears its end, future lending rate cuts hinge on effective transmission of rates under the MCLR structure (marginal cost of funds-based lending rate) and revival in investment activity.

What’s left?

Since the start of the rate-easing cycle in 2015, the RBI has cut its policy repo rate -- at which banks borrow short-term funds from the RBI -- by 150 basis points. Lending rates on outstanding loans have fallen by about 60-70 basis since then, while rates on fresh loans have fallen by 90-100 basis points.

One of the key reasons for the lag and shortfall in transmission of rate cuts (as in the past) has been the liquidity situation. In a tight liquidity scenario, banks are not able to reduce deposit rates substantially and, hence, lower lending rates, even in a falling rate cycle. Taking note of the banks’ plea to ease liquidity, the RBI had announced a slew of measures in its April policy, including open market operations (OMOs) — buying of government bonds — and various measures on the cash reserve ratio (CRR) and marginal standing facility (MSF) front.

While this has eased liquidity, banks have not cut lending rates aggressively in the last three to four months, even after the 25 basis points cut in the repo rate in the April policy. Many banks have cited possible volatility in rupee liquidity come September, when foreign currency non-resident (FCNR) deposits come up for redemption, as the reason for limited rate actions. The RBI though has assured ample liquidity to counter the shortage of rupee volatility. But sufficient liquidity alone may not trigger rate action by banks.

MCLR to be fine-tuned

Banks now price loans with reference to the new marginal cost of funds-based lending rate (MCLR). Most banks had set their MCLR 10-20 basis points lower than the erstwhile benchmark base rate, in April, when the MCLR came into force. But since then, leading banks have not reduced MCLR (one-year) substantially. Since the RBI’s June policy, for instance, most banks have cut MCLR only by about 5 basis points. This is because banks have not reduced deposit rates meaningfully for fear of the flight of deposits. Deposit growth within the banking sector has been anaemic at 9-10 per cent levels.

Even if banks lower MCLR going ahead, some of the issues in the MCLR framework, such as varying re-set periods (of lending rates) and banks tinkering with the mark-up (spread), will need to be ironed out for a better pass-through of lower rates. The RBI on Tuesday had indicated that it would possibly announce some changes to the MCLR shortly.

Revival in credit growth

While MCLR can force banks to lower lending rates to some extent, much of their rate actions hinge on the revival in investment activity. Weak credit growth (9-10 per cent) and rising bad loans that have already put margins under pressure, have left little wriggle room for banks to lower lending rates. Given the risk within the system, banks are also not too keen to compete on rates aggressively. Banks also yearn for a higher spread to compensate for the risk and, hence, may not lower their lending rates in a hurry.

Over to the MPC

The RBI Governor Raghuram Rajan indicated that the process to select members of the Monetary Policy Committee (MPC) has commenced. This means that the next monetary policy action could very well be from the newly constituted MPC. The panel will consist of six members -- three from the RBI and three from the Government. Given that the government only recently announced its intention to stick with the 4 per cent CPI inflation target for the next five years, it is unlikely that the monetary policy framework will undergo major structural changes.

The new MPC will decide on monetary policy by a majority vote. And if there’s a tie, the RBI governor gets the deciding vote. In most inflation targeting countries decision on policy rates is based on a majority vote, steered by a committee.

With India Inc. clamouring for rate cuts to spur growth, it needs to be seen if the MPC will be tempted to favour growth, while allowing itself some leeway on meeting the inflation target in the near-term.

Published on August 09, 2016
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