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Now that short-term borrowing rates are down sharply, will banks lower their lending rates?
Not really. Most public sector banks, which have held off rate increases until now, may go ahead and raise rates. Private sector ones, which may reap savings from the cut in MSF (marginal standing facility) rates, may not be in any hurry to pass them on to borrowers.
Banks may react differently to RBI’s rate tweaks on Friday because they aren’t all affected in the same way. This is because base rates, to which all lending rates are linked, are more a function of deposit rates than policy rates. How banks will react depends on three factors.
One, there are the savings they make on their incremental funds. Banks such as YES Bank and IndusInd Bank, which rely a lot on short-term deposits, may reap the most savings in cost from RBI’s tweaks.
For instance, the incremental benefit for YES Bank from these measures will be at least 50-75 basis points on new deposits. These banks are better placed to reduce lending rates, but may bide their time on it. Two, it also depends on the liquidity situation for individual banks. With a scramble for deposits, some banks may find it harder to prevent flight of deposits than others. These will be forced to keep deposit rates high. This again warrants a high base rate to safeguard margins.
For instance, SBI effected an increase of 10 basis points in base rates only on Thursday, after raising deposit rates across maturities.
Three, the extent of bad loan problems faced by a bank will also decide its ability to lower loan rates. As non-performing assets (NPAs) have been on the rise for most public sector banks, they have borne the brunt of the liquidity tightening measures. Consider this — SBI has gross non-performing assets of Rs 60,000 crore as of end-June.
This requires public sector banks to set aside additional funds as provisioning. Added to this is their daily CRR requirement of around Rs 60,000 crore.
As liquidity tightens, public sector banks with high NPAs will find it harder to reduce base rates. In fact, they may even raise lending rates.
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