Money & Banking

No Christmas gift, but some cheer for the New Year

Radhika Merwin BL Research Bureau | Updated on March 09, 2018 Published on December 02, 2014


Taking comfort from falling inflation, the RBI has signalled a possible rate cut early next year

The RBI Governor did not add to the year-end festivities by keeping the policy rates unchanged in the monetary policy on Tuesday. India Inc and banks who have been clamouring for lower rates, will have to wait a little longer. But that is not to say that the policy was entirely a non-event.

The RBI now appears comfortable achieving its January 2016 target of 6 per cent, and has signalled a possible rate cut early next year. If this happens, banks will be more ready to cut lending rates as declining deposit rates has reduced their cost of funds.

The rate-cut transmission is also likely to be faster this time around; thanks to the RBI moving away from a fixed repo rate regime, to a target rate for the short-term, early this year.

Rates softening

While the RBI may have disappointed some, by keeping the repo rate (the rate at which it lends to banks) unchanged at 8 per cent, borrowers can still find comfort as interest rates have already started to trend lower in recent months.

Many banks have been cutting rates across different term deposits. This has happened mainly due to ample liquidity and slower credit off-take.

Banks are flush with liquidity, which has given them enough headroom to lower deposit rates. Banks’ borrowing through the liquidity adjustment facility (LAF), which helps them to manage temporary mismatches, has been falling sharply in recent months. The borrowing through LAF, which averaged around ₹40,000 crore in the first half of the year, has halved since September, indicating ample liquidity in the banking system.

As a result, banks’ borrowing costs have come down by 30-40 basis points since January. This has helped few banks tweak their deposit rates.

Slowing credit growth has also prompted banks to lower rates on their deposits. With not enough lending opportunities to deploy their funds, banks prefer to shed high-cost deposits to retain margins.

Better transmission

With deposit rates already trending down, a rate cut early next year will see many banks passing on the benefit to lenders. In the past, when the RBI embarked on its easy money policy, banks did not responded readily. This has because of the ineffectiveness of the fixed repo rate as the policy rate and also due to the prevailing liquidity situation.

By adopting Urjit Patel Committee’s recommendation — to move out of the fixed repo rate regime to a target rate for the short-term, benchmarked against the 14-day term repo — the RBI has also ensured better transmission of its policy action this time around.

By providing funds at market-determined rates, the RBI is now able to control both liquidity and the rate at which it provides such funds. By tweaking the amount of liquidity that it provides to banks at each auction, it has now ensured that rates at the 14-day term repo move in sync with the RBI’s target policy rate.

All recent auctions of term repos have happened close to the current repo rate of 8 per cent. Any change in policy stance will quickly reflect on banks’ lending rates and benefit borrowers.

Published on December 02, 2014
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