Lending rates to fall gradually

With the RBI choosing to hold rates yet again, borrowers can expect only modest cuts in lending rates from 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 the 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 (marginal cost of funds-based lending rate) structure 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 60-70 basis points 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 the 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) fronts.

While this has eased liquidity, banks have not cut lending rates aggressively in the last three to four months, even after the 25-basis-point cut in repo rate in the April policy. Many banks have cited the possible volatility in rupee liquidity come September, when the 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 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 the MCLR only by about 5 basis points. This is because banks have not reduced their deposit rates meaningfully, for fear of flight of deposits. Deposit growth within the banking sector has been anaemic at 9-10 per cent levels.

Even if banks do lower the MCLR, going ahead, some of the issues in the MCLR framework, such as varying reset 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 the MCLR can force banks to lower the 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.

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