The RBI Governor seemed to have missed the Christmas spirit by keeping the policy rates unchanged in his monetary policy on Tuesday. While this was broadly expected, the RBI’s status quo on rates, will now limit further cuts in lending rates.
Borrowers will have to wait till the RBI resumes its rate cuts - possibly after the Budget announcement early next year -- for lending rates to move substantially lower from hereon.
While the RBI did nudge banks once again to hurry up with the full transmission of its cut in repo rate (since January) to borrowers, lending rates will only soften gradually over the coming months.
The RBI has lowered its key policy repo rate — at which banks borrow short-term funds from the RBI — by 125 basis points since January. While the central bank has done four rate cuts this year, what galvanised banks to lower lending rates was the steep 50 basis points cut in repo rate, in the previous September policy.
On an average, banks have reduced their base rates -- to which all lending rates are pegged — by 50-60 basis points since January; half of this was done post the RBI’s September rate cut and quick.
Base rate
Currently the base rate for banks ranges from 9.3 per cent to 9.7 per cent. SBI has the lowest base rate of 9.3 per cent, with HDFC Bank and ICICI bank close on the heels at 9.35 per cent.
There are few banks that still have base rates ruling high at more than 10 per cent -- Karnataka Bank, YES Bank, Karur Vysya Bank, City Union Bank and IndusInd Bank to name a few. But in the past too, these banks have had a higher base rate than most banks.
Important to note is that even these banks have lowered their base rates by 50-60 basis points since January in line with the broader industry trend.
Weighted average lending rate (WALR) on fresh loans sanctioned, according to RBI’s latest report has actually fallen by about 45 basis points between January and September 2015.
Clamour for more
Despite lending rates moving lower by a substantial amount and across the broad, many argue that there is still room for more cuts. This is because, lending rate cuts are still far lower than the 125 basis points repo rate cut by the RBI since January.
Deposit rates on the other hand have moved lower by 1-1.25 per cent since the beginning of the year. The RBI too has again urged banks to pass on more benefit to borrowers. But there are few reasons why further cuts in lending rates may be limited.
One of the main reasons for slower transmission has always been 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. Going by this, the RBI’s 125 basis point cut in repo rate, (at 50 per cent) then has been fully transmitted by banks.
This is also way above the level of transmission seen in the past. In the period between September 2008 and September 2009, for instance, the RBI had slashed the repo rate by 425 basis points. But borrowers had to make do with a mere 120 basis points cut in lending rates. In the recent past too, between March 2012 and June 2013, when repo rate fell by 125 basis points, only a fifth of this rate cut was passed on to borrowers.
Another reason for limited cuts in lending rates in the coming months, is also because public sector banks that have a lion’s share in lending are likely to be a lot more circumspect while cutting rates. Given their poor core performance and high level of stressed loans, lending rate cuts will only stress margins further.
Game changer
There are a couple of things that could facilitate better transmission in the coming months. Banks will have to calculate their base rates based on their marginal funding cost from April 2016. Until now, banks could set their base rate (minimum lending rate) after determining a spread over their total costs, but had the option of using either the average cost of funds or the marginal cost of funds.
This may force banks’ hands to cut lending rates as deposit rate increases or decreases will immediately reflect on the banks’ cost of funds and hence on lending rates.
Disconnect between rates that banks offer on deposits and market rates has also impeded policy transmission. Urging the Centre to review the interest rates on small savings scheme, which were kept unchanged this year, can give more headroom for banks to lower deposits rates and hence lending rates.
Establishing an independent benchmark administrator (as mentioned in April policy), which will publish various indices of market interest rates, can be used by banks to price their various products.