Money & Banking

After RBI repo rate cut, will banks reduce lending rates?

Radhika Merwin | Updated on August 07, 2019

While the RBI has nudged banks to hasten transmission, structural issues may limit steep lending rate cuts

BL Research Bureau

Caught between the devil and the deep blue sea, the RBI cut its policy repo rate by 35 basis points (bps) — above the ritual 25 bps, but below optimistic expectations of 50 bps. In all, the RBI has cut rates by 110 bps so far this year. But, given the slow pace of reduction in bank lending rates so far, how fast the RBI’s rate cut gets transmitted to borrowers in the form of lending rate cuts, will be critical.

Up until the recent policy review, banks had lowered their benchmark lending rate (MCLR) by just 10-20 bps, even though the RBI had cut the repo rate by 75 bps. In fact, some of the moves by banks, have come just ahead of the RBI’s policy review. SBI, after its recent sharp 50-75 bps cut in deposit rates in certain tenures, lowered MCLR by a lower 15 bps, just after the policy announcement today.

A tight liquidity condition and weak deposit growth vis-à-vis credit growth for private sector banks, had led to lower transmission of RBI’s rate cut to borrowers until recently.

With liquidity easing up somewhat and SBI cutting deposit rates sharply in the past month, lending rates could move lower in the coming months. However, with weak core performance of PSU banks, limited action by private banks on deposit rates and persisting structural issues in transmission, sharp lending rate cuts are unlikely.

Slow pace

Since banks source only a minuscule portion of their funds (1 per cent) from the repo window and rely significantly on longer term deposits; only about 50-60 per cent of banks’ funding gets re-priced. Hence, a cut in repo rate does not immediately reduce their costs, impeding lending rate cuts. This structural issue is likely to persist, and therefore cuts in the lending rates will happen with a lag, even this time around.

The tight liquidity situation had further weakened transmission in the past few months. In fact, going by the past rate cut cycle, the transmission has been much slower this time around.

Sample this, between January 2015 and October 2016 (before demonetisation), while the RBI cut repo rate by 175 basis points, lending rates on fresh loans came down by about one percentage point. Demonetisation, which led to flush deposits and sharp cut in deposit rates, had led to sharper lending rates in the months to follow.

Over the past one year even as the RBI’s repo rate fell by 75 basis points until the August policy, banks failed to transmit even half of the central bank’s action. While higher credit growth vis-à-vis deposit growth has constricted private banks’ ability to cut deposit rates sharply, already low deposit rates of PSU banks have limited their action on both deposits and lending rates.

Long wait

SBI recently cut deposit rates sharply. But, much of the rate cut has happened in the very short term — upto six month deposits. In the higher tenure deposits of over a year, deposit rate cut has been 10-20 bps.

Only few PSU Banks such as PNB and Bank of India have cut deposit rates across tenures 20-25 bps after SBI’s action. Among private sector banks, HDFC Bank has cut deposit rate in the 1-2 year bucket by 10 bps in August; a similar 10 bps cut in MCLR was done just ahead of the RBI policy. But a widespread reduction among all banks is awaited.

Also read: Why SBI slashing deposit rates, may not lead to huge cuts by private banks

Given that many private banks continue to sport a very high credit deposit ratio of 80-100 per cent, on the back of strong loan growth, sharp deposit rate cut may not come in a hurry. Also, SBI’s sharp cut in deposit rates has happened in the very short term deposits. Hence it has cut its MCLR by a much lower 15 bps, only short after today's policy announcement.

Even if other PSU banks cut deposit rates substantially in the months ahead, weak core performance will limit the transmission to lending rates. In the latest June quarter, net interest income of PSU Banks grew by a modest 6 per cent YoY.

Published on August 07, 2019

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