If events of the past year are any precedent, the RBI’s latest move to cut the repo rate by 25 basis points while keeping the cash reserve ratio (CRR) unchanged may not translate into immediate rate cuts for borrowers. Here’s why.
The backdrop
The RBI cut the repo rate (the rate at which it lends to banks) thrice in 2012-13. This translated into a cumulative reduction of 100 basis points. However, base rates (benchmark against which banks fix interest rates on loans) came down by only 30-50 basis points over the year. For instance, State Bank of India reduced its base rate by 30 basis points, ICICI Bank reduced it only once in April 2012 (by 25 basis points), while Axis Bank did not change its base rate throughout the year. This reflected the banks’ inability to pass on the benefit of lower rates due to limited scope for re-pricing (lower) deposits at their end.
The average term deposit rates declined only 10-20 basis points during 2012-13. In fact, some banks such as SBI and Punjab National Bank increased deposit rates towards the end of the year to mobilise deposits.
Liquidity constraints
This was a consequence of a liquidity crunch in the banking system. Loan growth in 2012-13 slowed down to 14 per cent, but deposit growth was even slower at 13 per cent. This led to a large portion of deposits (77 per cent) being lent out. A higher credit-deposit ratio constrains banks from increasing lending, and also limits scope for re-pricing deposits (lower). Since banks needed to maintain their net interest margin, they were reluctant to moderate their lending rates when the RBI cut the repo rate.
This situation is likely to continue. Though the liquidity deficit situation for banks has eased from last year, it still remains high. Currently, the net demand and time liabilities (NDTL) in the banking system is around Rs 75 lakh crore. Banks’ borrowing through the liquidity adjustment facility (LAF), which helps them to manage temporary liquidity mismatches, remains above RBI’s comfort level of 1 per cent of NDTL.
Despite moderating towards the end of April, the LAF averaged around Rs 80,000 crore in the month of April. This may prevent banks from passing on interest rate cuts in a hurry.
What could have helped was a cut in the cash reserve ratio, but this hope remained unfulfilled yet again. A lower CRR (cash to be maintained by banks with the RBI) would have meant lower funds blocked with the RBI at zero-interest rate. The RBI has reduced the limit on statutory liquidity ratio (SLR) securities maintained in the held-till-maturity category to 23 per cent of NDTL from the earlier 25 per cent. This means that the changes in market value for a higher proportion of SLR securities will now have to be accounted for in banks’ income statements. This will lead to higher volatility in the treasury income of banks.
The RBI has proposed an increase in risk weights on banks’ exposures to corporates that have unhedged forex exposure positions. This will impact banks’ earnings, depending on their exposure to such corporates.